Introduction
After multiple tumultuous years in the cruising industry, 2023 has been shaping up to be a year of high demand for the industry. However, in my previous article, I had a hold rating on Carnival Corporation (NYSE:CCL) while having a buy rating on its industry peer, Royal Caribbean (RCL). At the time of writing, my reasoning was that Carnival’s financial health and profitability forecast, in comparison to Royal Caribbean, was materially worse even as both companies were expected to benefit from the elevated demand environment. Since this opinion, Norwegian Cruise Lines (NCLH) and Royal Caribbean reported their earnings report, which hinted at a stronger-than-expected cruising demand environment. Therefore, as the elevated demand environment will also likely benefit Carnival in a meaningful way, I am upgrading my rating on CCL stock from a hold to a buy. In the upcoming earning in June, I believe it is reasonable for Carnival investors to look forward to an upwardly revised profit forecast and improving financial health due to the better-than-expected demand environment.
Elevated Demand
Industry demand, throughout 2023, was expected to be significantly better than the previous pandemic years showing strong recovery for all the cruise lines. On top of this expectation, recent earnings reports from Carnival’s industry peers suggest that the demand environment is even stronger than previously expected.
Royal Caribbean reported earnings on May 4th, and the company revised their guidance upward “as a result of a record-breaking WAVE season and accelerating demand for [the] cruise experiences.” The adjustment was not small. In the previous quarter, the company was expecting adjusted earnings per share in the range of $3.00 to $3.60; today, after the revision, the company is now expecting $4.40 to $4.80 in adjusted earnings per share for the full year. At the midpoint of both estimates, the company’s expectation jumped by 40% in a single quarter.
Regarding the positive adjustment, Royal Caribbean said that “the company experienced particularly strong close-in demand for Caribbean itineraries.” Further, the company saw that the “consumer spending onboard, as well as pre-cruise purchases, continue[d] to exceed 2019 levels driven by greater participation at higher prices.” Simply, Royal Caribbean is seeing record North American cruising demand driving prices higher, and even in an elevated price point, the consumers are continuing to spend at record levels on-board significantly benefiting the company as Royal Caribbean’s North American market exposure is about 76%.
I believe this particular phenomenon of better-than-expected demand could be played out for Carnival as well. Carnival has exposure to more global markets compared to Royal Caribbean; however, the company has the biggest exposure in North America. According to the 2023Q1 earnings report, about 60.8% of the company’s revenue came from North America, which in my opinion, gives ample exposure for the company to benefit from the record North American cruising demand.
Earnings report from Norwegian Cruise Lines further supports this argument. The management team said that the “cumulative booked position for the remainder of 2023 is ahead of 2019 levels, inclusive of ~18% increase in capacity, at higher pricing.” Despite the capacity increase, due to the strong demand, the company is seeing record load factors and bookings. Taking into account that Norwegian Cruise Lines has a 63.5% North American market exposure, which is similar to Carnival, the company’s outlook, in my opinion, could be followed by Carnival in the coming earnings report.
Overall, as the major industry peers to Carnival suggest, the demand environment is continuously getting stronger going into the busiest summer season, which will likely be the case for Carnival as well creating a stronger-than-expected tailwind for the company.
Financials
An elevated demand environment is crucial for Carnival as the company’s financial health, due to the pandemic, is not in its optimal position. The company, in 2023Q1, ending on February 28th, had about $5.5 billion in cash with about $32.3 billion in long-term debts, and the company had a total liability-to-asset ratio of about 88%. This led to the company’s quarterly interest expense of about $539 million, or about 12.2% of the total revenue. Given an elevated demand environment, the company’s debt load could be manageable, but I had a hold rating on the company in my previous article because of Carnival’s 2023 eps expectation. Analysts were forecasting Carnival to report -0.27 eps for fiscal 2023 despite an elevated demand environment. However, given that the company’s industry peers have reported a better-than-expected demand environment, I believe Carnival will likely follow by revising its eps estimate upward. This move will likely allow the company to lessen the pressure from the debt load and position the company for a stronger 2024. Therefore, despite a worrisome debt load, given an elevated demand environment, Carnival could work to overcome the current challenges.
Risk To Thesis
Carnival needs the cruising demand to stay elevated throughout 2023 and at least into 2024 due to the company’s high debt burden. If the demand and the favorable pricing environment falter, the company’s profitability forecast could be heavily affected. As such, investors should carefully monitor the macroeconomic conditions for signs of discretionary spending such as travel spending declining. Potential worsening macroeconomic conditions leading to reduced travel demand could be detrimental for Carnival.
Summary
Carnival is enjoying an elevated cruising demand environment after years of demand depression during the pandemic-driven lower demands. However, until the company’s industry peers including Royal Caribbean and Norwegian Cruise Lines forecasted a continuously elevating travel demand, I was less confident in Carnival. The company was expected to report a net loss for fiscal 2023 despite a positive demand environment with a massive debt load. However, given that it has become extremely likely for Carnival to experience a better-than-expected demand environment, I believe upwardly revising EPS estimates could be a possibility for reducing the financial burden the company has. Therefore, given the likely change of a stronger-than-expected demand environment with no signs of slowing demand, I believe Carnival is a buy.
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