Does Carnival's Current Ratio Present a Problem?

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Carnival (NYSE: CCL) is the biggest cruising company in the world. Carnival owns six separate cruise lines and travels to thousands of destinations around the world.

However, over the past five years Carnival has been in trouble. Due to falling consumer income, Carnival's earnings have come under pressure, and a series of very high profile disasters have given the company a lot of negative press.

With falling revenues and increasing media hostility, one thing that stands out about Carnival is its balance sheet. Carnival has a poor current ratio of less than 0.5, which signifies that the company will not be able to pay off all of its liabilities falling due within one year.

That said, Carnival does have more than enough assets to cover its total liabilities.

Carnival's Current Ratio

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>2008</p> </td> <td> <p>2009</p> </td> <td> <p>2010</p> </td> <td> <p>2011</p> </td> <td> <p>2012</p> </td> </tr> <tr> <td> <p>Total current assets</p> </td> <td> <p>$1,650</p> </td> <td> <p>$1,518</p> </td> <td> <p>$1,244</p> </td> <td> <p>$1,312</p> </td> <td> <p>$1,821</p> </td> </tr> <tr> <td> <p>Inventory</p> </td> <td> <p>$315</p> </td> <td> <p>$320</p> </td> <td> <p>$320</p> </td> <td> <p>$374</p> </td> <td> <p>$390</p> </td> </tr> <tr> <td> <p>Total current liabilities</p> </td> <td> <p>$5,781</p> </td> <td> <p>$4,967</p> </td> <td> <p>$5,755</p> </td> <td> <p>$6,105</p> </td> <td> <p>$7,340</p> </td> </tr> <tr> <td> <p>Current Ratio</p> </td> <td> <p>0.29</p> </td> <td> <p>0.31</p> </td> <td> <p>0.22</p> </td> <td> <p>0.21</p> </td> <td> <p>0.25</p> </td> </tr> <tr> <td> <p>Quick Ratio</p> </td> <td> <p>0.23</p> </td> <td> <p>0.24</p> </td> <td> <p>0.16</p> </td> <td> <p>0.15</p> </td> <td> <p>0.19</p> </td> </tr> </tbody> </table>

As the table shows, Carnival has not had a current ratio or quick ratio of more than 0.5 at any point over the last five year. Does this present a problem?

Well, when compared to its major competitors, it appears that a current ratio of 0.5 is the industry average.  The following two tables show the working capital of Carnival’s two main competitors, Royal Caribbean and Norwegian. Both Royal Caribbean and Norwegian do not have enough current assets to cover current liabilities - just like Carnival.

Royal Caribbean (NYSE: RCL)

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>2007</p> </td> <td> <p>2008</p> </td> <td> <p>2009</p> </td> <td> <p>2010</p> </td> <td> <p>2011</p> </td> </tr> <tr> <td> <p>Total current assets</p> </td> <td> <p>$993</p> </td> <td> <p>$977</p> </td> <td> <p>$1,026</p> </td> <td> <p>$1,015</p> </td> <td> <p>$969</p> </td> </tr> <tr> <td> <p>Inventory</p> </td> <td> <p>$97</p> </td> <td> <p>$96</p> </td> <td> <p>$108</p> </td> <td> <p>$127</p> </td> <td> <p>$145</p> </td> </tr> <tr> <td> <p>Total current liabilities</p> </td> <td> <p>$2,339</p> </td> <td> <p>$2,674</p> </td> <td> <p>$2,749</p> </td> <td> <p>$3,444</p> </td> <td> <p>$3,068</p> </td> </tr> <tr> <td> <p>Current Ratio</p> </td> <td> <p>0.42</p> </td> <td> <p>0.37</p> </td> <td> <p>0.37</p> </td> <td> <p>0.29</p> </td> <td> <p>0.32</p> </td> </tr> <tr> <td> <p>Quick Ratio</p> </td> <td> <p>0.38</p> </td> <td> <p>0.33</p> </td> <td> <p>0.33</p> </td> <td> <p>0.26</p> </td> <td> <p>0.27</p> </td> </tr> </tbody> </table>

Norwegian Cruise Line Holdings (NASDAQ: NCLH)

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>2010</p> </td> <td> <p>2011</p> </td> <td> <p>2012</p> </td> </tr> <tr> <td> <p>Total current assets</p> </td> <td> <p>$138</p> </td> <td> <p>$152</p> </td> <td> <p>$164</p> </td> </tr> <tr> <td> <p>Inventory</p> </td> <td> <p>$33</p> </td> <td> <p>$36</p> </td> <td> <p>$39</p> </td> </tr> <tr> <td> <p>Total current liabilities</p> </td> <td> <p>$653</p> </td> <td> <p>$817</p> </td> <td> <p>$945</p> </td> </tr> <tr> <td> <p>Current Ratio</p> </td> <td> <p>0.21</p> </td> <td> <p>0.19</p> </td> <td> <p>0.17</p> </td> </tr> <tr> <td> <p>Quick Ratio</p> </td> <td> <p>0.16</p> </td> <td> <p>0.14</p> </td> <td> <p>0.13</p> </td> </tr> </tbody> </table>

The problem is that with more liabilities than assets, these companies could face financial difficultly if there was a sudden cash call from their creditors.

<img src="/media/images/user_14485/cr1_large.png" />

The current ratio of all three companies has never exceeded more than 0.3.  But what about the longer term? Do these companies have enough assets to cover total liabilities?

The answer is yes, despite having poor working capital ratios all three companies have plenty of longer term assets to cover liabilities.  However, the majority of these long term assets are cruise ships, which could be hard to sell quickly if a sudden injection of cash was needed for the business. The other risk is that the ship sinks, which would incur additional costs to the company as well as a loss of assets.

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>Carnival</p> </td> <td> <p>Royal Caribbean</p> </td> <td> <p>NCL</p> </td> </tr> <tr> <td> <p>Total Assets</p> </td> <td> <p>$39,161</p> </td> <td> <p>$19,804</p> </td> <td> <p>$5,938</p> </td> </tr> <tr> <td> <p>Total Liabilities</p> </td> <td> <p>$15,232</p> </td> <td> <p>$11,397</p> </td> <td> <p>$3,919</p> </td> </tr> </tbody> </table>

On a longer term horizon these balance sheets look secure.  So why do cruise companies have poor working capital ratios?

On closer inspection, there is one huge current liability that is stuck right in the middles of each company's balance sheet. 

<img src="/media/images/user_14485/c3_large.png" />

Here, Carnival's largest liability falling due within one year is customer deposits. This huge amount has almost doubled the company’s current liabilities, and this same pattern is seen in both Royal Caribbean and Norwegian.

<img src="/media/images/user_14485/c2_large.png" />

Royal Caribbean and Norwegian both have the same liability of customer deposits on their balance sheets.

<img src="/media/images/user_14485/c1_large.png" />

There are three things that can happen to a customer deposit:

  1. The customer will go on the cruise; the company will keep the deposit and deduct it from the total cost of the client's cruise.
  2. The customer will cancel the cruise and the company will keep the security deposit.
  3. The company will cancel the cruise and the customer will be credited with the deposit. However, most companies will insure against this happening and any loss of earnings on the company's part will be paid out by the insurer.

So overall, customer deposit liabilities are not a real risk for the company, as for the most part they will end up as assets within 12 months.

With that in mind, what do the balance sheets of Carnival, Royal Caribbean, and Norwegian look like when customer deposits are removed?

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>Current Liabilities</p> </td> <td> <p>Current Assets</p> </td> <td> <p>Current Liabilities Excluding Customer Deposits</p> </td> <td> <p>Current Ratio</p> </td> <td> <p>Current Ratio Excluding Deposits</p> </td> </tr> <tr> <td> <p>CARNIVAL</p> </td> <td> <p>$5,940</p> </td> <td> <p>$1,940</p> </td> <td> <p>$2,862</p> </td> <td> <p>0.25</p> </td> <td> <p>0.68</p> </td> </tr> <tr> <td> <p>ROYAL CARIBBEAN</p> </td> <td> <p>$3,074</p> </td> <td> <p>$888</p> </td> <td> <p>$1,638</p> </td> <td> <p>0.32</p> </td> <td> <p>0.54</p> </td> </tr> <tr> <td> <p>NORWEGIAN CRUISE LINE HOLDINGS</p> </td> <td> <p>$945</p> </td> <td> <p>$164</p> </td> <td> <p>$591</p> </td> <td> <p>0.17</p> </td> <td> <p>0.28</p> </td> </tr> </tbody> </table>

Excluding customer deposits, the current ratios look slightly better, although not a single company has a ratio of more than 1.

<img src="/media/images/user_14485/q1c_large.png" />

Carnival's current ratio more than doubles with the exclusion of the customer deposits. 

The current ratio is still poor

Even with the exclusion of the customer deposits, current ratios across the group are still poor. Assuming the companies have access to credit markets, their current portions of debt will be easy to re-finance. So, how does their working capital look with the removal of current debt?

<table> <tbody> <tr> <td> <p>$US Million</p> </td> <td> <p>Current Liabilities Excluding Customer Deposits</p> </td> <td> <p>Current Portion of Long Term Debt</p> </td> <td> <p>Adj. Current Liabilities</p> </td> <td> <p>Current Assets</p> </td> <td> <p>Adj. Current Ratio</p> </td> </tr> <tr> <td> <p>CARNIVAL</p> </td> <td> <p>$2,862</p> </td> <td> <p>$754</p> </td> <td> <p>$2,108</p> </td> <td> <p>$1,940</p> </td> <td> <p>0.92</p> </td> </tr> <tr> <td> <p>ROYAL CARIBBEAN</p> </td> <td> <p>$1,638</p> </td> <td> <p>$638</p> </td> <td> <p>$1,000</p> </td> <td> <p>$888</p> </td> <td> <p>0.89</p> </td> </tr> <tr> <td> <p>NORWEGIAN CRUISE LINE HOLDINGS</p> </td> <td> <p>$591</p> </td> <td> <p>$221</p> </td> <td> <p>$370</p> </td> <td> <p>$164</p> </td> <td> <p>0.44</p> </td> </tr> </tbody> </table>

Assuming Carnival can re-finance its debt, the company has a current ratio of slightly less than 1. Royal Caribbean is in the same position; meanwhile, Norwegian continues to display a very poor current ratio.

Overall

So overall, Carnival's current ratio is not a problem as the majority of the company's current liabilities are customer deposits, and for the most part Carnival will be able to convert these liabilities into assets. In addition, Carnival's short term debt is not an issue, as the company should be able to re-finance itself. 

So, Carnival’s current ratio is nothing to worry about. That said, investors should be worried about the current ratios of both Royal Caribbean and Norwegian.

Even with the removal of customer deposits and short term debt from the current liabilities of Royal Caribbean and Norwegian, the companies still have poor current ratios of less than one. Indeed, Norwegian has a ratio of less than 0.5 - Carnival's current ratio is not a problem, but Norwegian's could be.

Data Source: Saxo Capital Markets, Marketwatch, Carnival


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