Buy Royal Caribbean Instead Of Carnival Corporation
Contributor since 2021 / 2208 Followers
Summary:
- Cruising industry is expected to see strong growth throughout 2023.
- While Carnival Cruise is expecting a loss in 2023, Royal Caribbean is expecting to return to profitability.
- Thus, I believe Royal Caribbean is a buy while Carnival is a hold.
guvendemir
Introduction
Customers are coming back. After years of the pandemic-driven demand depression, Royal Caribbean (NYSE:RCL) is seeing a strong demand environment throughout 2023. Stronger bookings and spending is driving the company to forecast strong profitability for 2023 and beyond. However, its biggest competitor, Carnival Cruise Line (NYSE:CCL), is expected to continue to report a net loss in 2023 showing a stark discrepancy. While a strong demand environment applies to both companies, Royal Caribbean’s relative strength in the balance sheet as well as less exposure to markets beyond Europe and North America allows the company, in my opinion, to thrive compared to Carnival. Therefore, ahead of a strong demand season with a manageable debt load, Royal Caribbean is a buy, unlike Carnival Cruise Line.
Strong demand environment
One thing that both companies agree on is that the demand environment for cruising continues to be strong. As consumers move away from the consumption of goods to services after the pandemic, travel demand is at a record high.
Carnival’s management team, in the recent earnings call, said that “we are still experiencing a record wave season,” and “we expect these favorable trends to continue based on the traction we’re making to our ongoing effort to drive demand globally,” which has allowed the company to overcome “over $30 million in headwinds from fuel price and currency” in the first quarter.
Similarly, Royal Caribbean in their latest earnings call said that “demand for our brands accelerated” to “a 95% load factor,” which has led to “pricing for [the] vacation experiences” to be “higher than record 2019 levels.” After a strong 2022, the company is “entering 2023 with full strength” as the company “continue(s) to see robust demand.”
Given this commentary, I believe it is reasonable to argue that the cruising industry, including both Carnival and Royal Caribbean, is expected to continue seeing strong demand in 2023.
The difference
While the cruising industry, in general, is experiencing a strong demand environment, my outlook for Carnival and Royal Caribbean is starkly different.
Carnival reported its 2023Q1 earnings report on March 27th, 2023, and the company is expecting losses of $550 to $350 million even on an expected occupancy percentage of 100% or higher. The company cited many reasons including rising costs due to inflation; however, in my opinion, the biggest weakness came from the company’s balance sheet with exposure to a significant amount of debt. As such, in 2023, the company is expecting to have an interest expense of $2 billion, which is a stark difference compared to an interest expense of about $200 million in 2019. Even with a strong demand leading to an expectation of a 100% or higher occupancy percentage, Carnival is expected to lose about $450 million. Therefore, the company’s return to profitability may be reliant on the industry remaining at record-level demand for an extended period of time, which is a significant risk that I do not wish to be exposed to.
On the other hand, Royal Caribbean is forecasting a completely different picture. According to the company’s 2022Q4, Royal Caribbean is expecting an adjusted EPS of $3 to $3.6 even with about 5% higher cost compared to 2019. Again, I view this phenomenon as a result of Royal Caribbean’s lighter debt load. For the full year 2023, the company is expecting to pay an interest expense of about $1.33 billion. In comparison to 2019 interest expense of $408 million, the company is incurring a relatively small $900 million increase, which starkly differs from Carnival’s $1.8 billion in extra interest expense. Further, revisiting Royal Caribbean’s statement made in 2022 of needing a “90% load factory” to start “generate(ing) profit,” the company’s future looks bright as the company’s 2022Q4 load factor was 95% with an expected load factor in 2023Q1 reaching 100%.
Overall, even in the same strong demand environment, Carnival is forecasting a dimmer future while Royal Caribbean is forecasting a much brighter one due to their respective debt loads. Thus, I believe Royal Caribbean is a buy while Carnival is a hold.
Why?
Beyond the two companies’ respective debt loads, I believe there are more determinant factors leading to two vastly different outlooks. In the case of Royal Caribbean, 100% of the company’s fleet was operating by June 2022 as the company focused on the US markets and European markets. However, this was not in the realm of possibility for Carnival with a greater footprint. The company’s fleet that used to service Asian markets was taking longer to come online, even when redirecting some of its fleets to markets with more robust demand. As such, it will naturally take Carnival longer than Royal Caribbean to return to full growth and profitability.
Valuation
Although Carnival is expecting a loss in 2023, the company is expecting positive earnings in 2024 with a 2024 forward-price-to-earnings ratio of about 10. Considering that the demand environment for cruising is expected to be strong throughout 2023 with no signs of slowdown as of today, I believe Carnival’s stock is a hold. Despite expected 2023 losses, the company’s 2024 expected valuation multiple is on par with Royal Caribbean. Thus, investors will need to constantly monitor the demand environment, but given that the current forecast continues, Carnival’s path to profitability will likely occur.
Royal Caribbean, on the other hand, is a buy in my opinion as the company is expecting profits with a 2023 forward price-to-earnings ratio of 18, which is expected to decline to 10 in 2024. As such, looking at the exceptionally strong demand environment with no signs of a slowdown, as of today, I believe the company’s profitability potential is attractive.
Risk: Financial health
Beyond macroeconomic risks including inflation, financial health is one of the biggest risks both companies face. With higher debt loads and interest expenses, both companies need a strong demand environment to persist throughout 2023 and beyond to lower their liabilities.
Although a higher debt load is a significant risk for both companies, when accounting for the past dividends the companies used to pay, I do not believe that the risk is as daunting as some investors point out. For example, Carnival Cruise is expecting to pay about $1.8 billion more in interest expenses in 2023 compared to 2019, but when accounting for the company’s $1.4 billion dividend payout, which has stopped today, the extra incurred cost difference becomes dramatically lower to about $500 million. Similarly, Royal Caribbean is expected to pay about $900 million more in interest expenses in 2023 compared to 2019, but when accounting for the company’s dividend payout of about $600 million in 2019, the extra cost comes down to about $300 million.
I do realize that the significantly higher debt load and its respective interest rates pose risks, but when considering the absence of dividends and strong demand today, I do not believe that both companies warrant a sell rating.
Summary
With a strong demand environment, the cruising industry is expected to be busy. However, with Carnival’s higher interest expense and slower return to full capacity, I believe investors should invest in Royal Caribbean. Benefiting from the same high-demand environment, Royal Caribbean has lighter interest expense and has fully deployed its fleet back in 2022. Therefore, I believe Royal Caribbean is a buy, unlike Carnival Cruise Line.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.