On June 25, Carnival Corp. (CCL, Financial), which operates the Carnival, Princess and Holland America cruise lines, reported strong demand and record operating income for its fiscal second quarter.
For the three months ended May 31, revenue hit $5.78 billion, up 17.70% year over year, and operating income was $560 million, up 102.90% from the prior quarter ($276 million).
People are flocking to cruises. Carnival said its bookings for the remainder of 2024 continues to be the best on record in both price (in constant currency) and occupancy.
The bottom line is Carnival stock looks deeply undervalued here. This analysis will show it is worth well over twice its present price.
Free cash flow is strong
The demand for Carnival's cruises has led to a huge cash inflow for the cruise line. Adjusted free cash flow remained strong at $1.36 billion during its fiscal second quarter. This was down slightly from the prior quarter's $1.36 billion. Nevertheless, its free cash flow margins are strong at 22.50% of revenue.
In fact, given that adjusted FCF for the quarter had a 25.20% margin, its FCF margin has averaged 23.80% for the past six months. This can be seen by dividing the $2.66 billion in FCF by $11.187 billion in revenue for the first half of fiscal 2024 (see the table below from Carnival's second-quarter earnings release).
Source: Carnival's second-quarter results
Moreover, management made a point of saying they expect to see strong cash flow going forward. Chief Financial Officer David Bernstein said, “Looking forward, we expect substantial free cash flow driven by our ongoing operational execution and the lowest newbuild order book in decades to deliver continued improvements in our leverage metrics and balance sheet.”
Debt reduction and possible future dividend payments
Given low capital expenditure requirements and with debt payments under control, it is possible that Carnival could return to paying a dividend. For example, the company has simplified its capital structure and reduced net interest expense by $54 million in 2024 and $85 million on an annualized basis.
Moreover, as of May 31, its outstanding debt maturities for the remainder of the year, 2025 and 2026 were $1.20 billion, $1.70 billion and $2.80 billion.
This is easily covered by forecasts of its adjusted FCF. For example, assuming Carnival makes average 22.50% adjusted FCF margins, the company could generate $5.58 billion in FCF this year (ending Nov. 30). This is based on analysts' revenue forecast of $24.81 billion.
And next year, using a 22.50% FCF margin against analysts' forecast of $26 billion, adjusted FCF could rise to $5.85 billion.
In fact, given that in the past six months the company generated 23.80% FCF margins, the next 12 months' average adjusted FCF could be even higher. Nevertheless, using this lower FCF margin, there is sufficient room to both pay down debt and potentially pay a dividend at the end of the year.
For example, the table below shows that this year after debt payments of $1.19 billion and assuming $5.58 billion in adjusted FCF, Carnival will still have $4.38 billion in remaining FCF.
Source: Second-quarter 10-Q report
Moreover, going forward the company could easily afford to pay dividends based on its cash flow outlook. This debt payment and dividend outlook does not include the fact Carnival also has over $1.64 billion in cash on hand.
Carnival last paid dividends to its shareholders in the first quarter of 2020 with a dividend of 50 cents. So if the company was to pay out just $1 billion quarterly in dividends (or less than half of the remainder after debt payments), it could afford to pay the 50-cent dividend again (given about 1.50 billion in net shares outstanding).
That would push the stock substantially higher, but it is not necessary for value investors right now. It is presently worth over double the price at the time of writing.
Valuation is over a two-bagger
One way to value a stock is to assume 100% of the company's free cash flow is paid out as a dividend. In that case, what would the dividend yield be? What would the market value the stock in terms of its dividend yield?
To be super conservative, let's assume the market gives Carnival a 10% dividend yield if it were to pay out 100% of its $5.58 billion in adjusted free cash flow.Here is how that works out:
$5.78 billion / 0.10 = $57.80 billion market value
That is 224% greater than its present $25.77 billion market cap as of July 5. In other words, the stock would be worth at least 220% more than its price of $17.21, or $38.55 per share.
The bottom line is Carnival's adjusted FCF could easily push the stock over twice its present price. That would especially be the case if the company decides to pay a dividend at the end of this fiscal year.
