Carnival Corporation (NYSE:CCL), the largest cruise company in the world, is still finding it difficult to break through to profitability on the back of stellar revenue growth. The fiscal second-quarter earnings of the company, reported on June 26, highlight some of the main challenges faced by the company in the post-pandemic era.
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A closer look at the macroeconomic outlook for the sector and Carnival’s market position suggests there is a long runway for growth for the company, but the short-term market performance will be highly volatile. I am bullish on the long-term prospects for Carnival, but I believe things may get worse before they get better from a stock-price perspective.
Growth Comes at a Cost
For the second quarter of Fiscal 2023, Carnival reported record revenue of $4.9 billion, registering year-over-year growth of 104.5%. Total bookings made during the quarter reached a new all-time high as well, and total customer deposits also reached an all-time high of $7.2 billion, surpassing the previous high of $6 billion set in May 2019 before the pandemic wreaked havoc on the cruise industry.
In a milestone achievement, Carnival reported an operating profit of $120 million for the fiscal second quarter, which marked the first time the company’s operating profit turned positive in the post-pandemic era.
Carnival stock fell more than 7% on June 26 despite the company reporting stellar growth, and this deterioration of investor sentiment can be attributed to a notable increase in costs. Cruise costs per available lower berth day, or ALBD, increased 8.3%, and adjusted cruise costs excluding fuel per ALBD rose 13.5% compared to Q2 2019. Higher spending on marketing and incentive compensation increases accounted for most of the overall cost increase.
Increased advertising expenditure has enabled the company to attract new customers, which is reflected in booking growth. During the second-quarter earnings call on June 26, Carnival CEO Josh Weinstein confirmed that advertising investments will be continued in the coming quarters to build demand for 2024 and beyond. Carnival having to incur additional marketing costs to lure new customers in the current macro environment could be an early indication of slowing demand for cruise travel.
The SEA Change Program
Along with second-quarter earnings, Carnival launched the SEA Change Program, a business strategy that focuses on achieving a set of financial goals by 2026. This program focuses on sustainability, EBITDA, and adjusted return on invested capital. The stated objectives of the SEA Change Program include a 20% reduction in carbon intensity compared to 2019, a 50% increase in adjusted EBITDA per ALBD compared to June 2023, and a doubling of ROIC to 12%.
These ambitious goals are within the company’s reach, considering the improvements seen in adjusted EBITDA over the last few quarters. With this program, the company is trying to achieve investment-grade leverage metrics by 2026. This is an encouraging strategy as Carnival’s balance sheet health deteriorated substantially at the peak of the pandemic, with the company having to aggressively issue both debt and equity to raise cash to survive the no-sail order by the CDC, which brought an abrupt end to its business operations.
The Improving Financial Position
The company, in recent quarters, has made commendable progress toward improving its liquidity position to manage the massive debt burden efficiently. The company carries close to $31 billion in long-term debt on its balance sheet compared to just $9.7 billion in November 2019, just before COVID-19 disrupted business.
In the second quarter of Fiscal 2023, Carnival paid $1 billion of variable-rate debt with maturities in the next couple of years. In total, the company allocated $1.8 billion in the second quarter to repay debt. In addition, this month, the company repaid $300 million of debt maturing in 2024 as well.
Helped by these repayments, its interest coverage ratio has improved, and the company ended the quarter with $7.3 billion of liquidity, alleviating any concerns over its ability to survive the challenging macroeconomic and geopolitical landscape.
Is Carnival Stock a Buy, According to Analysts?
Based on the ratings of 12 Wall Street analysts, the average Carnival stock price target is $15.89, which implies downside potential of 7.4% from the current market price.
Additionally, over two weeks ago, JPMorgan (NYSE:JPM) analyst Matthew Boss upgraded Carnival to a Buy and boosted his price target to $16 from $11, citing that there are no signs of a slowdown in the current booking momentum as the cruise industry continues to benefit from pent-up demand for travel.
The analyst also praised Carnival’s recent investments in improving the guest experience. Carnival is developing six private destinations in the Caribbean region, which is one of the most popular destinations among cruise travelers.
Carnival seems fairly valued based on analyst ratings, and the stock may come under some pressure in the short term as most of the positive developments are already factored into its market price. The company is expected to report positive adjusted profits in the next quarter, but full-year profitability is unlikely in Fiscal 2023. Corporate earnings, however, are likely to improve meaningfully in the next couple of years as inflation eases further and economic growth falls back on track.
Takeaway: Carnival’s Long-Term Outlook is Bright
Carnival, as the leader of the global cruise industry, enjoys scale advantages that could help the company enjoy economic profits in the long term. Earnings growth should lead to higher stock prices in the long run, which makes Carnival an appealing long-term investment opportunity. In the short term, however, Carnival stock may come under pressure because of an increase in its cost base.
