Without question, the COVID-19 pandemic had an impact Carnival (CCL -1.96%) and his peers in ways that will be felt for years to come. The cruise line and its competitors had to find a way to survive without revenue. But despite that challenge, passengers still want to take cruises, a factor that has helped Carnival’s earnings sail higher again.
However, the pandemic exposed both green flags and red flags for Carnival stock. Investors should weigh the benefits and challenges before considering a position in this stock.
Green Flag: Market leadership
One factor that stayed in place was Carnival’s market leadership among cruise line stocks. According to Cruise Market Watch, 42% of all cruise passengers sailed on a Carnival-owned ship. That was way ahead Royal Caribbean in 24% and Norwegianwhich claimed about 10%.
This lead has positioned Carnival well now that demand has returned. Carnival had placed more than 90% of its fleet back in service by the end of its fiscal second quarter, which ended May 31. Moreover, the frequency increased to 69%.
This does not compare to fiscal year 2019 (which ended on November 30 of that year), when occupancy could exceed 100% after placing more than two passengers in a room. However, utilization increased at a time when capacity increased by 25%. Since Carnival operates the largest fleet, it was positioned to accommodate growing demand.
That process has begun after bringing in more than $4 billion in revenue in the first half of fiscal 2022. While that’s still well below the $9.5 billion generated in the first half of 2019, it’s on track to recovery. But the loss in the first two quarters of 2022 of $3.7 billion shows that the recovery process is ongoing.
However, analysts predict a 710% increase in revenue for 2022 as Carnival moves to full operations. They also believe that Carnival can grow revenue by an additional 61% and become profitable in 2023. This growth could lead to a return to full capacity in the foreseeable future.
Red flag: Massive debt
The problem that will probably plague Carnival for years to come is the debt it racked up to keep the company afloat. Carnival carried just over $11 billion in total debt at the end of fiscal 2019.
But at the time, Carnival held just $2 billion in cash on its balance sheet. That gave Carnival a modest cushion, but not enough to survive more than a year with its only significant source of revenue gone.
Therefore, Carnival had to take on massive additional debt. At the end of the second fiscal quarter, total debt rose to $35 billion. With shareholders’ equity at just under $8.3 billion, Carnival’s balance sheet is under tremendous strain.
Also, Carnival generated negative free cash flow of more than $4.4 billion in the first half of 2022. Interestingly, this comes in slightly higher than the same period in 2021 when negative free cash flow amounted to slightly less than 5 billion dollars. This means that even if analysts have correctly predicted that profitability will return in 2023, Carnival’s debt situation could keep the company in troubled waters for years.
Should I consider Carnival stock?
From an investor perspective, Carnival doesn’t look like a winner. With cruise demand remaining strong, Carnival will probably survive and return to profitability. However, its massive debt will limit the company’s options for years to come, making it more challenging to attract investors. Thus, investors should probably consider companies and businesses with relatively smaller debt levels.
Will Healy has no position in any of the stocks mentioned. The Motley Fool recommends Carnival. The Motley Fool has a disclosure policy.
