Carnival still weighed down by debt pile

Miami-based Carnival’s (CCL) shares hit a three-decade low last September, but investor sentiment had turned a corner in advance of the results. The share price has risen by over 80 per cent year-to-date as expectations of a rampant cruise sector recovery have grown to new heights. But the more than 10 per cent mark-down on results day, despite a guidance upgrade and growth across a range of other metrics, suggested that the market was expecting too much, too fast. Analysts at Truist Securities said the reaction was a “sell on the news” moment.

Carnival’s postings were certainly further evidence of the rebound in cruise travel demand after the decimation caused by the pandemic. Revenues in the second quarter were a company record, as were bookings for future sailings and customer deposits.

There were fears in the not too distant past of a permanent levelling off in travel demand, but by this point this hypothesis can be set aside. The Cruise Lines International Association (CLIA) forecasts that cruise passenger volumes this year will be 6 per cent ahead of pre-pandemic levels.

Carnival's occupancy rate came in at 95 per cent in the period and improved to 98 per cent in the second quarter. The company said that its advanced booking position for the rest of the year "is near the high end of the historical range", a good position to be in given ticket prices are pricier than in 2019.

The good news allowed management to increase its cash profit guidance for the year to a range of $4.10bn-$4.24bn. 

But despite financial progress and positive signs for consumer demand, the debt overhang and liquidity issues at Carnival simply can’t be ignored. While the company has paid down more than $1bn in variable rate debt since February, the huge debt pile is a constraint. Principal payments on outstanding debt will rise over the next few years to $4.5bn in 2026, and the net interest expense in the first half was an eyewatering $1.04bn.

Analysts at Moody’s noted last autumn that “free cash flow available for debt reduction will continue to be constrained by rising interest costs and new ship commitments”. Rates have, of course, risen significantly since then and variable rates apply to around a fifth of the company's debt.

The ratings agency assesses Carnival’s debt at B2 negative, which it describes as speculative and risky. The company hopes to reach investment grade gearing levels by 2026.

Elsewhere, some disconcerting comments in the company's outlook statement may have impacted the share price movement. Management said full-year cruise costs would be higher than it expected in March due to "a slower expected ramp down in inflationary pressures" and that incentive compensation and advertising investment costs will rise. 

Whether Carnival can achieve the key performance indicators in its new 'sea change programme', which include hitting an adjusted return on invested capital (ROIC) of 12 per cent, remains to be seen. But for now, we have no plans to get onboard. Sell. 

Last IC view: Sell, 773p, 25 Aug 2022