Monday’s market surge was a remarkable sight. Hopes are clearly high that an effective vaccine will allow the world to return to normal. Travel firms were among the biggest winners — Carnival (LSE: CCL) shares rose by 35%, while easyJet (LSE: EZJ) shares ended the day 33% higher.
The mood remains positive today. As I write, shares in both firms are rising strongly. Should I be buying Carnival or easyJet shares in case the world does return to normal next year?
easyJet shares: ready for take-off?
easyJet boss Johan Lundgren wisely chose to raise cash by selling new shares quite early in the year. Back in June, Lundgren raised £419m at a share price of 703p. Since then, easyJet’s share price has fallen as low as 470p.
In my view, Lundgren’s done well to minimise shareholder dilution. But despite this fundraising, easyJet’s net debt rose from £326m to £1.1bn during the year to 30 September. Since then, I estimate this figure has risen further, to about £1.4bn.
This increased borrowing has kept the company afloat, but it will need to be repaid at some point. How easy will this be?
As a rule, I prefer to invest in companies where net debt is less than four times net profits. In 2019, easyJet generated a net profit of £349m. With profits at that level, the airline’s net debt would be four times its profits.
I could live with that level of gearing, but airline industry forecasts suggest it will be 2023 before traffic returns to 2019 levels. City analysts expect easyJet to report a £190m loss in 2021.
On balance, I think easyJet has done enough to survive and recover. Although I wouldn’t rule out another equity fundraising, I think the firm will probably avoid this. I wouldn’t sell easyJet shares if I already held them, but I don’t feel enough conviction to want to buy.
I think Carnival shares could sink again
I believe Carnival’s debt position is far more extreme than easyJet’s. By my calculations, the company’s net debt has now risen to around $18bn, up from about $11bn at the end of November 2019. To put that in context, Carnival’s 2019 net profit was just under $3bn.
Last year, I thought Carnival’s debt levels were high enough, but I wasn’t concerned. The company appeared to be trading well.
Fast-forward to today, and the situation looks quite different. Almost all the firm’s fleet is still parked up, idle. Meanwhile, borrowings have risen to around six times historic peak profits.
How long will it take for the firm’s trading to return to 2019 levels? It’s too soon to know. At a guess, I’d say it could take two or three years, assuming the pandemic eases by next summer.
I think that Carnival’s cruise brands will remain market-leading businesses. But, in my view, the company is likely to need a major refinancing at some point. This would mean selling new shares to bring its debts down to a more manageable level. Existing shareholders could face significant dilution.
For me, Carnival is a little too speculative. Right now, if I was forced to invest in the travel sector, I’d probably choose easyJet shares.
The post Carnival and easyJet shares: should I buy now? appeared first on The Motley Fool UK.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020