Why Carnival Fell Today, and What It Has to Do With Zombies – The Motley Fool

What happened

Just in time for Stranger Things, season 4, an article published by Bloomberg Wednesday morning announced the arrival of ... "zombie firms" in America. And, to the consternation of investors in cruise line stocks, the reporter named Carnival (CCL -3.91%) as one of them.

Carnival stock closed the session down by 3%. Rival operators Royal Caribbean (RCL -2.46%) and Norwegian Cruise Line Holdings (NCLH -2.80%), which are arguably in the same boat as Carnival, were down by 4.3% and 4.5%, respectively.

Image source: Getty Images.

What are "zombie firms," you ask? Bloomberg News' Lisa Lee defines them as "creations of easy credit, beneficiaries of central bank largesse," and "companies that aren't earning enough to cover their interest expenses, let alone turn a profit" -- and she warns that "their time may be running short" as interest rates rise and banks tighten lending standards.

How does this work in dollars and (per)cents? Citing the example of Carnival's recent issuance of $1 billion worth of senior unsecured notes due in 2030 -- a bond offering that sent cruise stocks sailing higher, by the way -- the article points out that Carnival had to offer interest rates in excess of 10% to attract buyers. As I pointed out at the time, though, Carnival plans to use the funds raised from that new debt to pay interest installments on previously existing debt that's costing it only 5.5% interest. And as Lee's article points out, just seven months ago, Carnival was able to float $2 billion worth of bonds at an interest rate of just 6%.

So clearly, things are getting worse. Credit standards are tightening, and debt is getting more expensive. But how big of a problem is this for Carnival -- and for Royal Caribbean and Norwegian Cruise, too, for that matter?

Let's go to the tape. (Which is to say, let's review the numbers on S&P Global Market Intelligence.)

In the first quarter, Carnival generated a gross profit of just $156 million, but paid out $365 million in interest. That alone shows the situation isn't great. Add in its $1.6 billion in operating costs, and Carnival is operating deeply in the red.

Royal Caribbean is in even direr straits. Both its operating profit and its gross profit are very negative. It has no profits at all that it can apply to the $278 million in interest it owes quarterly. And it's the same story for Norwegian Cruise: $139 million in interest comes due every quarter -- but it has neither any gross nor operating profits with which to cover that expense.

Now, the good news is that summer is here, and the cruise business is picking up. By the third quarter, Wall Street analysts see the situation changing for the better, with Carnival, Royal Caribbean, and Norwegian Cruise expected to not just turn profitable on an operating basis, but to generate operating profits more than sufficient to meet their debt obligations.

That means that in just another few months, all three of these "zombie firms" should be able to come back to life -- assuming no further macroeconomic headwinds arise. Moreover, given that Carnival has $6.9 billion in cash in the bank, Norwegian Cruise has $2.1 billion, andRoyal Caribbean has $1.9 billion, all three of these cruise companies appear to have what they'll need to bridge the gap between zombieland and resuscitation.

Long story short, Bloomberg's Lee may be right that all these cruise companies are currently zombies -- but the good news is that they're only mostly dead, and could still get better.

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Why Carnival Fell Today, and What It Has to Do With Zombies - The Motley Fool

Reviewed and Recommended by Erik Baquero