They had to build a special runway just to get him down.”
It seems like every day there is another high street shock – a well-known retail brand giving up the struggle. The coronavirus has sped up a Darwinian shift towards online shopping. The rot has spread to owners of shopping malls and high-street property. Yet, we aren’t seeing a similar capitulations across other sectors impacted by the virus – particularly transport and travel. Markets are pricing for these sectors to stage pretty much a full recovery.
In normal markets what makes companies tick is cash flow - if a company doesn’t generate cash and has bills to pay… that’s a problem. Not any more.. The rules have changed… Liquidity is so plentiful there is an assumption companies can simply keep borrowing to see themselves out the Virus crisis. Debt apparently does not matter. Liquidity has never been so easy due to QE Infinity, Negative Interest Rates and multiple Virus Bailouts.
Right or wrongly, it’s never been easier for Zombie companies to survive on the simple assumption they can keep borrowing. It’s a circular argument. As long as interest rates remain low, then they can simply leverage up. If they can borrow, they can borrow more. And, that’s quite extraordinary bearing in mind how many highly leveraged companies are generating zero cash flow due to the pandemic..
You are probably thinking.. “that sounds dangerous…”
What if the assumptions behind all that debt are wrong? Bad assumptions have been the catalyst for all the great credit market crashes. I remember the Great Perp Crash of 1986 – when investors mistakenly assumed banks would honour calls on cheap subordinated debt. When someone pointed out banks were under no obligation to repay effectively free capital early… the market tumbled 20-30%.
It was the questionable assumptions underlying Mortgage Backed lending that triggered the 2007/08 Global financial crisis.
Right now I’m thinking about the over $200 bln that’s been raised in emergency funding by airlines, shipping companies and other issuers involved in those sectors most heavily impacted by the Coronavirus. Much of that money has been raised on a secured basis: including planes and cruise ships. We still don’t know just how quickly, if at all, these sectors will reopen. It’s clear there is a glut of the underlying assets – raising questions about valuations. Yet, these recent Covid Asset-Backed funding deals have been tightening in line with the general credit market!
For anyone holding the Carnival Cruise Lines Loan and Bond issues, or who invested in the Royal Caribbean bailout, this morning’s photo is some boats similar to the assets backing your investment. I snapped it as we passed eight cruise liners lying at anchor off Portland on the South Coast of England last week. Earlier the same day we’d sailed past more of these ocean behemoths lying idle off Bournemouth.
I wonder what sort of future exists for these ghost fleets? Will they end up like the German High Seas fleet rotting on the bottom of Scapa Flow?
It doesn’t take a genius to figure out that all these cruise liners must be costing someone a pretty penny. A cruise liner costs around $10mm a month to run in “warm storage” – and Carnival has over 100 of them. None of them is earning a penny.
Cruise liner bosses say demand for cruises remains robust. Apparently more than 50% of passengers are taking the option of deferring refunds to take deals like a 125% credit on future bookings when cruising starts again. There was a surge in demand when a limited August series of cruises from Florida was announced – whether they happen is another matter as cruising has now been banned in US through September.
Even after putting boats on sale, and looking to scrap others, Carnival is still burning more than six hundred million dollars per month just to stay, ahem, “afloat”. It’s been to markets repeatedly – raising a $4 bln bond in April at 11%, then $2 bln from the loan market, and came back for another $1.3 bln bond deal last week. Although the company says its solvent for at least a year, I must be missing something. I think it will back again for more cash before October/November… They will say something like: “we’re borrowing now because we can, not because we are forced to..” but under that calm exterior, the cruise line will be paddling furiously!
Interestingly the second bond, is also secured but subordinated to the first deal (but is still senior secured to Carnival’s senior debt!!). That infers massive over-collateralization of the underlying assets – the perceived value of these cruise ships moored up in the English Channel. The second deal also carries a lower coupon, reflecting the fact Carnival’s April bond issue has tightened nearly 9 price points since launch.
Marvelous, but the price tightened in line with market because while the company might now be junk-rated, but still counts as Investment Grade for Fed purposes. If you accept that premise, I have a host of similar asset secured bonds you might like to buy…
Carnival is still bleeding cash, with zero income and mounting bills, and its interest payments on new borrowing must be getting on for $70mm per month? Selling boats might be an option – if anyone was buying! Faced with a feast of unwanted cruise ships, scrap dealers are going to cut their bids to the bone.
None of that matters… the market is making assumptions around Carnival being able to keep borrowing, the Coronavirus being short-lived, and Carnival will soon deliver to the pent-up customer demand for cruises, thus make enough money to cover its debt load again.
But, even if Carnival could get itself fully functional tomorrow on the back of a vaccine or a similar miracle, the state of these boats sitting in the English Channel laid up isn’t great. Up close they look rusty and tired. Passengers go on cruises for their opulence - they don’t do scruffy and in need of a lick of paint.
Before they sail again, all these boats will require substantial refurbishment. The companies will have to go recruit and retrain crew, (don’t imagine all the Filipino crew who get treated like indentured labour are desperate to return.) The boats will need re-provisioning and restocking. Just bunkering them (fuelling up) will take time and logistical planning to get cruising businesses functional again. Cruise liners thrive on being used. If they are in service, they are receiving constant daily maintenance. If they sit in a wet, salty ocean… they rust. There was a brilliant article on Bloomberg the other week: The World’s Cruise Liners Can’t Sail. What to do with them? If you are of a delicate disposition, don’t read the part describing what happens to the plumbing systems when they aren’t regularly used. In short.. unused boats rot.
It’s not just cruise liners that are going stale.
The aircraft optimistically parked on wet runways in Ireland and the UK for a few weeks back in March are going to require major recertification and work to put back in the air. That’s why most aircraft get stored in dry desert bone-yards. Much of the airport infrastructure is also going stale. Flying is not going to get any easier – it’s going to become increasingly bureaucratic!
(Years ago they built a magnificent airport with a suspiciously long runway out in Knock, Nowheresville, Ireland… an astute priest got it built to facilitate pilgrimages to see a moving statue (or did it bleed?) in his church, but we suspect NATO wanted somewhere to land B52s if things got unpleasant with the Ruskies. Now they’ve finally found a use for the airport – its become a site for scrapping A380s! Sad….)
Boeing is in a similar mess as Carnival. There is not an airline on the planet that wants new planes - when so many are for sale cheap! Boeing managed to avoid a bailout, and took $26 bln from the bond market. But it’s still not shifting the grounded B-737 Max – which looks like it may get permission to fly again in October, but no one is really wanting to fly it anymore. It’s still building 787 Dreamliners – but the order book is pretty bare. Boeing’s new aircraft, the B-777x isn’t on any airlines wish-list. Yet, Boeing’s stock price (which is the worst performer on S&P) is still 80% up on its nadir in March. I can’t think of a single positive thing to say about the plane maker. And its bonds have tightened… why? Oh.. because that is the way the market works…
My point is the market is making assumptions about the future value of companies and their assets that don’t seem rational in this new uncertain world. The underlying assets aren’t standing the test of time, the weather and the looming recession. Factor crashing real asset values into your investment equations.
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