Carnival (CCL) will report earnings on Tuesday before the open. The options market implies a substantial earnings-related move of about 8%, much more than the 5% earnings-related move the company has averaged since mid-2013. We’ll review an options trade that generates some income into the results. Investors wonder whether the cruise industry can sustain robust bookings from the early part of the year through 2024 year-end. Carnival is one of the companies whose operations were affected by the cargo ship collision in Baltimore and the subsequent collapse of the Francis Scott Key Bridge, as they operated in that port. However, the company did not anticipate a meaningful impact from the temporary shift of those operations to Norfolk, Virginia. Another question investors may have is when Carnival will resume paying a dividend. The company suspended its dividend in early 2020 due to the pandemic-related closures, but the expectation is that the dividend will resume as soon as the business normalizes. With revenues nearly 20% higher than pre-pandemic 2019 levels and forward estimated free cash flow exceeding the pre-pandemic dividend payments of 1.5 billion in 2019, investors may believe this will happen sooner rather than later. Full-year 2024 estimated EBITDA of about $5.7 billion is higher than the 2019 pre-pandemic high of $5.6 billion (non-inflation adjusted). However, the total debt of $32 billion is nearly 3 times pre-pandemic levels. Management may hold off a bit longer before resuming. Carnival’s current valuation at 8 times EV/EBITDA and less than 13 times forward estimated earnings estimates is quite reasonable, particularly given global conflicts and the fact that, as I’ve previously written, their demographic skews towards the more affordable end of the spectrum, a consumer group that may generally be more affected by the higher prices that have resulted from several years of well-above-average inflation. Both the dividend and debt levels have important implications for the stock’s volatility, the price of options generally, and the relationship between the price of puts and calls. The trade All else equal, higher levels of corporate debt increase leverage and, therefore, the volatility of a company’s equity. Carnival’s revenues are 20% greater than they were immediately before the pandemic, and so is its enterprise value. Thus, the enterprise value-to-sales ratio is approximately the same. However, the company’s debt level is much higher, so we would expect the equity volatility to similarly be much higher. The greater the equity volatility, the greater the price of options. Carnival’s options are nearly twice as expensive now as they were at the end of 2019, but the higher levels of debt justify higher prices. Because stockholders are entitled to dividends while holders of call options on that stock are not, as dividends rise, all else equal, the value of call options falls relative to the value of the corresponding puts. Therefore, if one expects dividends to increase, or in Carnival’s case, resume, owning call options may not be the best way to take a long bet on the stock, even if dividends increase demand to own it — many investors prefer stocks that pay dividends. We favor selling covered calls against a long position in Carnival generally as the company pays down debt, bookings, and free cash flow grow, and in anticipation of the resumption of the dividend. Typically, we do not recommend selling covered calls into earnings unless options prices are very high, as earnings provide a catalyst that can move a stock. In this case, an 8% implied move is substantial, but due to the high debt levels, it merely represents a fair price for the options. The trade: Sell June 19 $18 call If one initiates a buy-write before earnings, the yield is compelling, but waiting until afterward is OK too. I just wouldn’t expect to get quite the same yield as buying now. DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
