Carnival Corp. (CCL) Cut to Junk by S&P

Carnival Corp. (NYSE: CCL) Cut to Junk by S&P

The firm cited:

• We believe the cruise industry may face an extended period of weak demand that will cause global cruise operator Carnival Corp.'s credit measures to remain very weak through at least 2021 as it implements a phased resumption of its cruises and given incremental debt raises to bolster its liquidity while its operations remain suspended. Furthermore, there remains a high level of uncertainty around when and how the company will resume its service and its ultimate recovery path.
• We are lowering our issuer credit rating on Carnival to 'BB-' from 'BBB-', our issue-level rating on its secured notes to 'BB+' from 'BBB-', and our issue-level rating on its unsecured debt to 'BB-' from 'BBB-'. We are also assigning our '1' recovery rating to the secured notes and our '3' recovery rating to the unsecured debt.
• All of our ratings on the company remain on CreditWatch, where we initially placed them with negative implications on March 10, 2020.
• At the same time, we assigned our 'BB+' issue-level rating and '1' recovery rating to the company's proposed $1.5 billion of secured term loans and placed the issue-level rating on CreditWatch with negative implications. Carnival plans to add the proceeds from this issuance to its balance sheet to enhance its liquidity.
• In resolving the CreditWatch, we will monitor Carnival's ability to resume its operations this year, evaluate its prospects for improving its profitability in 2021, and assess whether it can begin to significantly reduce its very high anticipated leverage after 2021. We also intend to assess how the pandemic may alter the level of travel or cruise demand over the longer term.

We expect Carnival's credit measures to remain very weak through 2021 because of its plans for a gradual reintroduction of capacity and our forecast for continued weak demand. We forecast that the company's credit measures will remain very weak through 2021 and anticipate that its adjusted leverage may potentially exceed 10x in 2021 following a significant deterioration in its performance in 2020 due to the temporary suspension of its operations since mid-March. Our updated forecast reflects our expectation that Carnival may begin to bring its capacity back online in a phased manner as early as September 2020. Resuming its operations in a phased manner may help the company better align its supply and demand, target easily accessible homeports, and better manage its itineraries because we believe its initial itineraries will be limited due to continued port closures and local government and health authority requirements. Additionally, we believe it may take multiple months for Carnival to bring all of its ships back into service and expect that the coronavirus pandemic will lead the company to accelerate the removal of its older ships and delay new ship deliveries. Our updated forecast for 2021 assumes very high leverage, which compares with our previous estimate that Carnival would improve its leverage back to the mid- to high-3x area in 2021. We now expect the company's EBITDA to be significantly more negative in 2020 because of expenses to repatriate its guests and crew that were higher than we anticipated and the incremental expenses associated with its need to keep more ships out of service for longer than we had previously assumed. Currently, we believe Carnival's recovery will be much slower in 2021 given its plan to return to service in phases.

Our revised 2021 forecast now contemplates:

• Net revenue yields decline by about 10%-20% from 2019 levels because of weaker expected demand and customer utilization of future cruise credits. This compares with our prior forecast for 2021 net yields of about 6%-8% below 2019 levels;
• Total revenue remains 25%-30% below 2019 levels because of weaker net revenue yields, a gradual reintroduction of capacity that reduces available lower berth days compared with 2019, and our expectation that Carnival may operate at much lower occupancy as it resumes its operations. We believe the company's capacity will not reach 2019 levels by the end of 2021 because of management's plan for a phased return to service as it tries to manage its supply with demand, determine available itineraries, and accelerate its disposal of older ships (Carnival indicated it intends to dispose of at least six ships);
• We believe cruise operators will implement social distancing and other health and safety measures on their ships to reduce the spread of the virus. We believe these social distancing measures may limit the maximum potential occupancy of the ships and potentially reduce their operators' profitability and cash flow. We also believe that lower demand and lingering travel fears may hurt their occupancy;
• Net cruise costs per available lower berth day (ALBD), excluding fuel, remain elevated above 2019 levels into 2021 given the incremental expenses associated with keeping ships out of service and the costs related to bringing them back online. This compares with our prior forecast that 2021 net cruise costs would be flat to slightly below 2019 levels;
• We believe Carnival may be able to limit its margin compression as it ramps up its fleet. Specifically, we anticipate the company could maintain reduced levels of marketing and selling expenses, particularly because it will have fewer ships to market, and believe it could manage certain ship-level expenses--like fuel, food, and crew payroll--to align with its potential reduced ship occupancy;
• These assumptions translate into EBITDA that is 50%-60% below 2019 levels;
• Given our significantly more negative forecast for EBITDA in 2020 and slower recovery in 2021, we now estimate its debt levels will be materially higher in 2021 at about $25 billion as of the end of the year, which compares with our prior forecast for debt of about $20 billion; and
• Nevertheless, we believe there continues to be a high degree of variability in our currently contemplated recovery path, particularly with respect to how its consumers will respond to continued flare-ups or waves of the virus in the absence of a vaccine or effective treatment. Although the consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, it will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021.

We believe that in 2022, Carnival may generate sufficient EBITDA to reduce its adjusted leverage below 6x if its demand begins to recover and net yields improve closer to 2019 levels while its net cruise costs per ALBD (excluding fuel) moderate closer to 2019 levels. If the company improved its adjusted leverage to this level, we would view it as in line with our current 'BB-' issuer credit rating.

We believe Carnival's scale offers it less protection from cash flow volatility given its industry's high capital intensity and its need to take delivery of ordered ships regardless of its operating environment. The cruise industry is highly capital intensive and operators generally must commit to new ship deliveries at least a few years in advance. While the operators generally obtain financing commitments for the ships before their delivery, which provides them with liquidity in case their cash flow declines, the incremental debt can significantly weaken their credit measures during periods of operating weakness because their debt balances increase while their EBITDA declines. Prior to the pandemic, we believed Carnival benefitted from its large scale in terms of cash flow generation because it could internally fund at least four to five large ship purchases each year with internally generated funds. Given its very negative EBITDA this year and our expectation that it will likely take multiple years for Carnival's cash flow to recover to pre-pandemic levels, we believe the company's planned ship orders will materially slow the recovery in its credit measures because its capital expenditures (capex) for new ships will likely exceed its EBITDA potentially through 2022. That said, we expect ship deliveries across the industry to be delayed by a few months, at least over the next few years, due--in part--to the temporary closure of shipyards to prevent the spread of the coronavirus. We believe Carnival will also accelerate the removal of older ships from its fleet over the next few quarters to help manage its supply and demand.

During periods of steeply declining demand, the incremental capacity from new ships can exacerbate industry pricing pressure as operators try to match their supply with demand. Although operators can take ships out of service to manage their capacity, they still incur expenses to keep the ships laid up. Although these expenses are relatively minimal on a per-ship basis, for Carnival--which has a large fleet of just over 100 ships,-- the expenses associated with keeping their ships out of service weigh on profitability. Because we believe the cruise industry may face an extended period of weak demand, we believe the company's attempts to manage its supply and demand may translate into lower-than-historical EBITDA margin for a few years. Specifically, we believe Carnival's EBITDA margin may remain below its historical level -the mid- to high-20% area for an extended period.

We believe Carnival has sufficient sources of liquidity to fund its liquidity needs over the next year. Notwithstanding our forecast that its credit measures will remain very weak through 2021, we believe Carnival has sufficient sources of liquidity to fund its cash needs over the next year.

As of May 31, 2020, Carnival had $7.6 billion of available liquidity. We believe this liquidity, in conjunction with the proceeds from its proposed $1.5 billion term loan and committed ship financing (which typically covers around 80% of the cost of a ship at delivery), should be sufficient to cover the company's cash needs for the remainder of the current fiscal year (Carnival's fiscal year ends Nov. 30, 2020) and into 2021.

The company's cash uses include:

• Between $5 billion and $6 billion of negative operating cash flow in 2020 due to materially negative EBITDA and a large working capital cash outflow. We expect Carnival's working capital to be a material cash outflow of between $2 billion and $3 billion this year, a large portion of which we believe it recognized in the second quarter. This is because we assume its customer deposits will decline significantly by the end of the year due to a heightened level of cash refunds associated with its cancelled cruises and reflects our expectation for lower pricing on the cruises booked in the second half of fiscal year 2020. We believe the company's operating cash flow may remain negative in early 2021 as it continues to phase in capacity and ramp up its operations;
• Our estimate for capex of modestly below $4 billion in 2020 and modestly higher than $4 billion of capex in 2021. Carnival previously had five ships scheduled for delivery in 2020, though we we believe delays may shift the timing of this capex to future periods; and
• About $1.2 billion of debt maturities in the second half of 2020 and about $1.3 billion in the first half of 2021. Our estimate for the company's debt maturities is net of approximately $600 million in certain ship loan amortization payments that Carnival is not expected to begin repaying until either March or May 2021.

Environmental, social, and governance (ESG) credit factors for this credit rating change:

• Health and safety

The CreditWatch listing reflects the substantial uncertainty around Carnival's recovery path for later this year and into 2021. In resolving the CreditWatch, we will assess the company's ability to resume operation this year and its prospects for improving its profitability and reducing its very high leverage. Furthermore, we plan to assess how the pandemic might alter the level of travel or cruise demand over the longer term.

We could lower our ratings on Carnival if we no longer believe it can recover and generate sufficient operating cash flow to begin to significantly reduce its very high adjusted leverage or if the company's liquidity position deteriorates.

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