Carnival: Profits In Sight
Contributor since 2011 / 25017 Followers
Summary:
- Carnival Corporation has seen a significant recovery in revenues but has incurred a lot of dilution and leverage since the pandemic.
- The company’s operating losses have narrowed, as the business is now breaking even, with real profits anticipated in 2024.
- Despite a solid outlook for 2024, this does not feel like the right time to invest, as expectations are still quite demanding in relation to earnings power and risks.
Lorraine Boogich
At the start of October, I thought that Carnival Corporation (NYSE:CCL) looked more compelling, yet I was still not yet willing to get onboard. Shares had fallen by a third since the summer, even as the company delivered on its promises and narrowed its losses.
While revenues had recovered a lot post-pandemic, the company has incurred a lot of dilution in terms of a greater share count and in the form of a leveraged balance sheet. With the risk-reward improving, I believed that Carnival was more or less breaking even at best, facing potential challenges if demand would unexpectedly retreat.
The Pandemic – Permanent Impairment
Pre-pandemic, Carnival was a $21 billion business which posted operating profits of around $3 billion per annum, with earnings reported around $4 per share based on a share count of around 700 million shares. Trading at $50, the company was granted a $35 billion equity valuation, or $47 billion enterprise valuation if we factor in net debt of around $12 billion. This was huge in dollar terms, but of course relates to the asset-intensive nature of the business.
Revenues plunged to less than $6 billion in 2020 and even less than $2 billion in 2021, resulting in huge operating losses of $9 billion and $7 billion, respectively, for those two years, although they included some impairment charges as well.
The company saw revenues recover to $12 billion in 2022, and despite the strong recovery, Carnival still posted an operating loss of around $4 billion that year. These losses came at a huge expense, with the share count having risen from 700 million shares in 2019 to 1.26 billion shares in 2022, as net debt jumped to $30 billion as well.
2023 – A Mighty Recovery
First quarter revenues for 2023 recovered to $4.3 billion, with operating losses narrowing to $172 million. Second quarter sales recovered to $4.9 billion as an operating profit of $120 million was reported.
Third quarter results, which includes the key holiday season, revealed at $6.9 billion sales number on which operating profits of $1.6 billion were reported, as continued dilution meant that the share count of 1.40 billion shares (after the convertible debt was trading in the money) had doubled from 2019 while net debt ticked down to $28.5 billion.
The company guided for full year EBITDA between $4.1 and $4.2 billion after this metric already came in at $3.3 billion year to date post the third quarter, with the business seeing some small headwinds from higher fuel costs and a stronger dollar. While the EBITDA number looks strong, it comes ahead of massive capital spending requirements and of course sizeable interest payments due, marking that realistic earnings were not seen.
It was this limited deleveraging power and the fact that market conditions were very strong, including occupancy rates which were reported in excess of 100%, which made it hard to see how the company could deleverage.
A Big Recovery
A $14 stock early in October traded at levels around $11 per share by the end of the month. What followed was a free fall in interest rate in November and December, which pushed shares up to a current level of $19, on par with the highs seen in the summer.
While Carnival has quite a fixed and long term debt profile, over time, lower interest rates work down on the massive debt load, as the lower interest rate environment has provided an impetus to the shares here.
Moreover, the fourth quarter sales results of $5.4 billion looked solid as well, which made that annual revenues of $21.6 billion came in on par with the 2019 results. After posting a $384 million operating profit in the final quarter, full year operating profits nearly totaled $2 billion. After accounting for interest expenses, the company essentially broke even for the quarter and the year, while the business posted an EBITDA number of $4.23 billion. Net debt actually ticked down to $28.1 billion, aided by record customer deposits of $6.4 billion.
Comforting was that the company guided for 2024 EBITDA to come in at $5.6 billion, as a $1.4 billion improvement on that front should largely flow to the bottom line, as that could easily make that break-even results would improve to earnings of around a dollar per share. There is great visibility in these earnings (absent of fluctuations in fuel prices and one-off events) with two-thirds of trips being booked already (at higher prices).
That looks highly promising as leverage ratios would still be sky-high but a 5 times leverage ratio has not been so low anymore since the start of the pandemic, all while lower interest rates provide a lifeline as well (no pun intended).
A Final Word
The truth is that Carnival continues to surprise towards the upside, as operating leverage has been impressive, and in fact is set to allow for realistic earnings in the upcoming year, which is better than I imagined.
Earnings power of around a dollar looks highly compelling, with deleveraging and further growth potentially driving upside to that number, driven by demographic trends among others. On the other side, there still is the issue of high debt, and the fact that cruise operators are susceptible to situations such as a pandemic, but of course general economic conditions as well.
Moreover, free cash flow is still another thing from profits, as forfeiting capital expenditures has resulted in the observation that capital spending of over $4 billion in 2024 will come in at nearly twice the annual depreciation expense, putting a considerable drag on free cash flow, as current conditions might even open the door for an opportunistic equity raise.
After the big run in the shares in just a few weeks time, this is not the time to get involved with Carnival, despite the solid outlook for 2024. Given all of this, I continue to grow my appreciation of Carnival here, but see no reason to get involved at prevailing levels.
Analyst’s 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.
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