The Carnival share price has rebounded 40%! Should I buy now?

Announcements about several Covid vaccines have caused the Carnival (LSE:CCL) share price to soar by 40% since October. The news of a vaccine soon becoming available is undeniably light at the end of the tunnel. However, it is important to remember, there is still some time to go before it can be distributed around the world.

Why did the Carnival share price initially sink?

It’s been a tough year for shareholders of the cruise line operator. With safety concerns for its passengers, the firm is following the guidance of the Centers for Disease Control and Prevention (CDC). Subsequently, all cruise trips have been suspended with the earliest restart date expected to come in January 2021.

These cancellations and customer refunds have wreaked havoc on the financial health of the company. Even though their cruise ships remained parked in harbours, the costs of maintaining them haven’t changed. 

The high operational costs of the business created high barriers to entry for competitors. However, this competitive advantage has turned into a serious liability over the past year. 

Debt levels are rising!

To remain afloat (pardon the pun) Carnival has been taking on additional debt as well as issuing new shares through equity offerings.

As of August, total debt stood at $18.9bn after it successfully acquired approximately $9.2bn of additional funding through credit facilities, secured notes, and convertible notes. While it is undoubtedly good news that Carnival secured additional financing, it does raise concerns.

As part of these agreements, certain limitations are in place that restrict how much of the capital structure can consist of debt. Specifically, the firm must maintain a minimum debt service coverage – EBITDA-to-interest – of three-to-one. Put simply, the company must be making sufficient profits to cover three times its interest payments to debt holders.

With the business nearing that ratio due to the lack of sales, its ability to continue relying on debt financing is quickly diminishing. 

While most of this new debt does not need to be repaid until after 2024, its existing obligations are coming due and may drastically affect the Carnival share price.

Is the Carnival share price a bargain or a trap?

Assuming the company can keep up with interest payments and operations return to normal soon, then the current share price does look quite appealing in my eyes.

But there is a high level of risk. Suppose the worst case comes to pass and the firm declares bankruptcy. In that case, shareholders are would experience losses, even at the current low share price.

There is currently $50bn in assets on the balance sheet, $37bn of which is in the form of cruise ships. These can probably only be liquidated at an average of 40% of their reported value. Of the remaining $27.8bn, $19bn will be used to repay debts, which leaves a rough estimate of $8.8bn available to equity holders. When compared to the current Carnival share price — or $15bn market cap — shareholders are likely to experience a 46% decline in value, almost everything that was gained these past weeks.