Carnival Corporation: On A Cruise

At the end of March I noted that Carnival Corporation (NYSE:CCL) was plugging the leak as the 2023 guidance suggested that the company could turn break-even, even after accounting for steep interest expenses. Positively surprised by this observation, I believed that the remaining debt load would cast a continued burden on the shares, although the recent operating momentum was a pleasant surprise.

Over the most recent quarter, Carnival has seen some accelerating momentum, giving investors a carte blanche to push shares higher aggressively.

A Base Case

Given the huge impact of the pandemic, I typically have a quick look back to 2019, the last normal year of operations. At the time, the company generated $21 billion in sales on which an operating profit of $3.3 billion was reported, rusting in earnings per share of $4 per share based on a share count of 700 million shares.

With shares trading at $50 at the time, the company commanded a $35 billion equity valuation, or $47 billion enterprise valuation if we add the net debt load of the business. This debt load was large in actual number terms, and in relation to earnings, but note that this is a very asset-intensive business of course.

Revenues fell to $5.6 billion (accompanied by a $9 billion operating loss) in the year 2020, as sales fell to just $1.9 billion in 2021 (with losses reported at $7 billion). The company saw a big improvement in 2022 with first quarter sales reported at $1.6 billion and second quarter sales improving to $2.4 billion, as the company still lost $3 billion for the first six months of 2022.

Third quarter sales rose to $4.3 billion as operating losses narrowed to $279 million. Fourth quarter sales came in at $3.8 billion (in a seasonally softer quarter) as 2022 revenues rose to a more respectable $12.1 billion, still accompanied by a big loss of course at more than $4 billion.

Dilution made that the share count has risen to 1.26 billion shares (marking 80% dilution since 2019) as net debt has risen from $12 billion in 2019 to $30 billion in 2022. That created a dire picture, although that the company was off to a good start for the first quarter (ending in February of this year). Revenues rose to $4.3 billion, with operating losses narrowing to just $172 million.

With the company guiding for $4 billion in EBITDA in 2023 (after posting an adjusted EBITDA number of $382 million in the first quarter), I believed that realistic break-even levels would be achievable. While break-even levels were beneficial, I noted that debt was high, interest rates were increasing and that the company had deferred quite some capital spending, with occupancy rates already being quite high (limiting the potential to increase occupancy rates without incurring new capital spending).

That made me cautious, although I recognized that I have been more positive on the shares than I have been for a while, although I could not commit to the shares at $10.

Too Cautious

Since March shares of Carnival have seen a huge rally as they have risen from $10 to $18 in the time frame of merely a quarter. This run was driven by the actual results, with second quarter sales reported at $4.9 billion, which is actually nearly one hundred million more than the same quarter back in 2019.

Amidst a decline in fuel prices, the company posted a strong operating profit of $120 million. This is of course ahead of interest expenses, as a net loss of $407 million appeared on the bottom line. Adjusted EBITDA was reported at $681 million, for a $1.1 billion number in the first half of the year.

The company is preparing for a very strong third quarter as the full year midpoint of the EBITDA guidance has been hiked by $175 million to $4.175 billion, driven by more than 100% occupancy rates and strong pricing. In the seasonally strong third quarter, EBITDA is seen at a midpoint of $2.1 billion, suggesting that quarterly profits could reach a billion.

Moreover, net debt has been stable and has actually come down to $29.3 billion, in part the result of very strong customer deposits which rose to $7.2 billion. With 1.26 billion shares now trading at $18, the market value has risen to nearly $23 billion, for a $52 billion enterprise valuation. This actually slightly exceeds the 2019 numbers, even as shares are still down two-thirds from the prevailing share price at the time.

All this is very promising, but a $4.2 billion EBITDA number for the year still makes it hard to see great earnings. After all, deprecation charges run at $2.4 billion, and they will need to be replenished (likely with higher capital spending) as net interest expenses run at around $2 billion. This results in no real earnings, but still break-even realistically might be achieved.

What Now?

The reality is that I have been too cautious when green shoots appeared this spring, as shares have risen some 80% ever since, adding about ten billion to the market value of the firm. The reality is that at these levels, it is really hard to deleverage rapidly (although the higher share prices open the window for continued share sales over time).

That being said, I am still positively surprised by the recent operating momentum, but given the vulnerability to a setback (mainly due to the debt load) I have no business being involved with either the equity or debt here.

If you like to see more ideas, please subscribe to the premium service "Value in Corporate Events" here and try the free trial. In this service, we cover major earnings events, M&A, IPOs, and other significant corporate events with actionable ideas. Furthermore, we provide coverage of situations and names on request!