Carnival (CCL) will report earnings Tuesday before the open. The options market implies a substantial earnings change of around 8%, well above the company’s average earnings change of 5% since mid-2013. We will look at an options trade that generates income in the results. Investors are questioning whether the cruise industry can maintain robust bookings from the start of the year through the end of 2024. Carnival is one of the companies whose operations were affected by the freighter collision in Baltimore and by the subsequent collapse of the Francis Scott Key Bridge, as they operated in that port. However, the company did not anticipate a significant impact from temporarily moving these operations to Norfolk, Virginia. Another question investors may have is when Carnival will start paying dividends again. The company suspended its dividend in early 2020 due to pandemic-related shutdowns, but the dividend is expected to resume as soon as business normalizes. With revenues nearly 20% above pre-pandemic levels in 2019 and free cash flow estimated to exceed pre-pandemic dividend payments of $1.5 billion in 2019, investors can believe this will happen as soon as possible. Estimated full-year 2024 EBITDA of approximately $5.7 billion is higher than the pre-pandemic peak of $5.6 billion in 2019 (not adjusted for inflation). However, the total debt of $32 billion is nearly three times higher than pre-pandemic levels. Management could wait a little longer before resuming. Carnival’s current valuation, at 8 times EV/EBITDA and less than 13 times forward earnings estimates, is entirely reasonable, especially given global conflicts and the fact that, as I have previously writing, their demographics lean toward the more affordable end of the spectrum, a consumer group that may generally be more affected by higher prices resulting from several years of well-above-average inflation. Dividend and debt levels have important implications for stock volatility, option pricing in general, and the relationship between put and call option pricing. All else equal, higher debt levels increase leverage and, therefore, the volatility of a company’s equity. Carnival’s revenue is 20% higher than it was immediately before the pandemic, as is its enterprise value. So the company value to sales ratio is about the same. However, the company’s debt level is much higher, so we expect stock volatility to be much higher as well. The greater the volatility of stocks, the higher the price of options. Carnival’s options are almost twice as expensive today as they were at the end of 2019, but higher debt levels justify higher prices. Since shareholders are entitled to dividends while holders of call options on those shares are not, as dividends increase, all else being equal, the value of call options decreases relative to the value of the corresponding puts. Therefore, if dividends are expected to rise, or in Carnival’s case, to resume, holding call options may not be the best way to make a long bet on the stock, although dividends increase holding demand – many investors prefer stocks that pay dividends. . We generally favor writing covered calls against a long position in Carnival as the company pays down debt, bookings and free cash flow increase, and in anticipation of dividend resumption. As a general rule, we do not recommend writing earnings covered calls unless option prices are very high, because earnings are a catalyst that can move a stock. In this case, an implied change of 8% is substantial, but due to the high debt levels it only represents a fair price for the options. The trade: Sell June 19: call at $18. If one initiates a buy-sell transaction before earnings, the return is convincing, but waiting afterwards is also acceptable. I just wouldn’t expect to get the same return as buying now. Disclosures: (None) Any opinions expressed by 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 distributed by them at television, radio, Internet or other media. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY. THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO PURCHASE ANY SECURITIES OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT THE UNIQUE PERSONAL CIRCUMSTANCES OF ANY INDIVIDUAL. THE ABOVE CONTENT MAY NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISION, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for full disclaimer.
