Carnival’s Ship Is Coming In
Still coming off a near-death experience as a result of the pandemic, it doesn’t take much to send cruise-line investors rushing for the lifeboats.
When a Bank of America analyst warned of “modestly softer pricing” for oceangoing companies on June 14, it knocked industry-leader Carnival’s shares by 7%. But on Tuesday the company’s fiscal second-quarter results assuaged those fears and then some. Carnival beat earnings and revenue expectations handily, raised full-year financial guidance and, perhaps most important, signaled that 2025, with modest growth in industry capacity, could look even better.
Carnival’s stock was the top performer in the S&P 500 on Tuesday. William Blair analyst Sharon Zackfia was among those raising forecasts. She noted that “demand trends bode well for considerable pricing power in 2025.”
“We are hitting records on top of previous records” a positively gleeful Carnival chief Josh Weinstein said on an investor call, noting for example that adjusted earnings before interest, tax, depreciation and amortization was the company’s highest in 15 years.
Look below the waterline, though, and Carnival is a different company than it was before the day that “Covid-19” entered our vocabulary. That is why its shares remain more than 60% below their January 2020 level. Long-term debt is almost triple, and shares outstanding nearly double their levels in those happier times. The important thing now is how quickly Carnival rights its balance sheet. While its debt is still in junk territory, it was upgraded Tuesday by Standard & Poor’s to BB, two levels below investment grade.
“There will be a transfer of the enterprise value from the debt holder to the shareholder,” David Bernstein, Carnival’s chief financial officer, said in an interview.
In other words, as the company’s free cash flow is directed solely at paying down borrowings or building up cash, the share price should benefit proportionately. Maybe even disproportionately: The impact might be better than cash going to stock buybacks or dividends since it will remove a discount that still weighs on Carnival’s valuation. Many institutional investors eschew companies that recently flirted with bankruptcy.
“There are a lot of portfolios that are hesitant to book companies that are incredibly leveraged,” admitted Bernstein.
Carnival and its competitors also took on a lot of expensive debt to stay afloat during the pandemic. Simply being able to refinance some of it more cheaply will benefit their bottom lines.
Getting a better return on their huge fixed assets will speed up that process. Carnival’s net yield, an industry measure of revenue less commissions and other costs per available cruise day, increased more than expected during the second quarter and the company raised its forecast for the back half of the year.
To get a sense of how important it is, Carnival estimates in a sensitivity analysis that a 1% increase in net yield would boost its net income by $97 million in the second half of fiscal 2024. And occupancy hit 104% during the second quarter compared with 98% a year ago (some cabins hold an extra passenger).
Especially encouraging is what Carnival and its competitors can’t do now that fares and occupancy are so high: order new ships. Many less-efficient vessels were scrapped, and there will be slow growth in 2026 and 2027 as the absence of industry orders during the height of the pandemic works its way through specialized shipyards. That will lead to record free cash flow for Carnival in coming years despite projects such as outfitting a Bahamian private beach, Celebration Key, as a cruise destination—a cost-saving and revenue-raising measure.
Even after Tuesday’s 8.7% rally, Carnival’s shares only trade at around 8.4 times enterprise value to forward Ebitda. That compares with an average of about 9.6 times in the 10 years before the pandemic. The best time to buy Carnival’s shares was when their price reflected a real threat of bankruptcy. The second best time might be now.
Write to Spencer Jakab at [email protected]