Carnival Corporation (CCL, Financial) is optimistic about the future as cruising demand in the U.S. remains high and financial results indicate better-than-expected bookings. It is a welcome change for investors since substantial debt is saddled onto the balance sheet at the moment. At one point not too long ago, investors were counting down how long it would take before the company's cash burn pushed it to insolvency. However, the positive demand environment does not guarantee profitability, and the company is still expected to face challenges related to debt and higher interest expenses.
Personally, I believe the company has a chance at posting an operating profit this year, which could begin to de-risk liquidity throughout 2023. While this would be a promising development, it might turn out to be just a drop in the bucket.
Recovering but weighted down by debt
Here is quick recap of the company's pre-Covid situation. In 2019, the company generated nearly $21 billion in sales and earned an operating profit of $3.3 billion. At the end of that year, the company had $12 billion in net debt load on its books. The debt was large but necessary for an asset-intensive cruise line business.
However, due to the pandemic, the company's revenue dropped to $5.6 billion in 2020, and it incurred an operating loss of $9 billion, partially due to significant write-downs. In 2021, sales fell further to $1.9 billion, and operating losses were $7 billion. In the first half of 2022, revenue improved to $1.6 billion in the first quarter and $2.4 billion in the second quarter, but the company still faced a massive $3 billion operating loss. A blend of inflation and preliminary operational deficits caused this.
Although the third quarter of 2022 showed an encouraging increase in sales to $4.3 billion and a reduction in operating losses to $279 million, the company continued to face $1.6 billion in annual interest expenses. The share count had also increased from 700 million to 1.2 billion by the third quarter, leading to substantial dilution. Net debt surged from $12 billion in 2019 to $30 billion in 2022.
In the fourth quarter of 2022, sales increased to $3.8 billion, bringing full-year revenues to $12.1 billion. However, despite the significant annual improvement, the company still reported an operating loss of $1.1 billion for the fourth quarter, with net interest expenses still at $1.6 billion per year and net debt now exceeding $30 billion.
In March, the company announced that first-quarter 2023 revenues had increased to $4.3 billion, with operating losses narrowing to $172 million due to operating leverage. Net debt has stabilized around the $30 billion level through deferred investments, and there has been no more share dilution over the last quarter.
Although the company predicted some improvements in 2023 due to higher occupancy rates, it will be challenging to see significant progress. Occupancy rates had already been at a high of 85%, and there would be a need for large capital expenditures to increase revenue further. Consequently, it looks challenging to view the company positively from a fundamental perspective, especially given the high cost of financing operations.
Gearing up for a big year
Carnival's shares have performed well since the beginning of the year, rising from a 52-week low of $6.11 to over $10 at the time of writing.
For 2023, the company expects adjusted Ebitda to be around $4 billion, driven by strong demand This is compared to first-quarter Ebitda of $382 million, indicating an expected quarterly average of around $1 billion. This suggests a potential improvement of $600 million per quarter and a realistic break-even level in the coming quarters (operating profits minus interest expenses).
Although this improvement is positive, it does not significantly reduce the debt load. Due to the asset-intensive nature of the business, there is a need for ongoing net capital investments, and the cash flow requirements remain significant. Additionally, occupancy rates are almost at 100%, which leaves little space for sequential improvements.
Macroeconomic risks are also a danger
Carnival is a company that heavily relies on the demand for vacations to generate revenue and maintain its profitability. With a high debt burden, the company needs to ensure that its operations are generating enough cash flow to pay down its debt and remain sustainable in the long term.
Economic conditions heavily influence the demand for non-essentials like cruises. As such, any economic downturns could lead to a drop in cruising demand, hurting Carnival's revenue streams. Investors should monitor the macroeconomic conditions that affect discretionary spending, particularly travel spending, as any adverse changes could impact Carnival's profitability forecast.
It's worth noting that the travel industry is sensitive to geopolitical events and natural disasters, which can disrupt travel plans and negatively affect the demand for cruises.
As the global economy recovers from the pandemic, investors should pay attention to consumer sentiment and travel trends to understand how demand for cruises will be affected. It's also essential to monitor the company's debt levels and financial performance to evaluate its ability to weather any downturns in the industry.
Takeaway
In conclusion, while the demand for cruising has been robust over the last few months, investors should be aware that Carnival's situation remains precarious and external factors could impact the travel industry's demand. There really isn't much room for error.
Despite the challenges, I am currently feeling more positive about Carnival than I have in a while. The company's guidance suggests that it will be able to post operating profits this year and may even cover most of its interest bill, which is a promising development. Given the higher debt and shareholder dilution, returning to pre-pandemic revenue and operating profit levels would mean the stock is worth about a quarter of the pre-pandemic prices, but even then it would appear to be undervalued.
