After a devastating pandemic shutdown and a reemergence, Carnival Cruise Lines (NYSE: CCL) is finally surpassing 2019 levels on several metrics. Ships are near full capacity, and pent-up demand for cruises has brought record bookings in an uncertain economy.
Still, the question for investors is whether this recent performance will help the stock. Even though Carnival has surged this year, financial challenges remain. Hence, one has to look more closely at the cruise line stock‘s business and financials to decide whether to invest.
In one key respect, Carnival has recovered from the pandemic. Consumers seem to have an insatiable demand for cruise vacations. In the second quarter of 2023, approximately 3 million passengers took a Carnival cruise, up from 1.7 million in the year-ago quarter. That led to a 98% occupancy rate.
Moreover, bookings are now at an all-time high. That brought customer deposits — initial payments required to confirm a reservation — to an all-time high of $7.2 billion, well above the previous record of $6 billion set in 2019.
This increased interest in cruising led to record second-quarter revenue of $4.9 billion. That was an increase of 105% year over year, though Carnival was still recovering from the pandemic in the second quarter of 2022.
Though its operating expenses rose significantly, Carnival achieved a milestone by recording its first operating profit in years. In Q2, the operating income was $120 million, up from nearly $1.5 billion in operating losses in the year-ago quarter.
To this end, investors have felt good enough about Carnival’s future to take the stock price almost 90% higher since the beginning of the year. And the stock trades at a price-to-sales (P/S) ratio of just 1.1, well below historical averages.
Unfortunately for Carnival, the legacy of the pandemic continues to haunt the cruise line — namely, in the form of its $35 billion total debt, most of which it accumulated to survive an extended shutdown during the pandemic.
Servicing that debt cost Carnival $542 million in Q2, leading to a net loss of $402 million during the quarter. While that’s a vast improvement from the $1.8 billion loss in the second quarter of 2022, it’s a reminder of how its debt continues to weigh on the company.
The debt hurts Carnival in numerous ways, and not just with its ongoing net losses. The 98% occupancy rate would typically be a sign to add capacity. But with so much debt, it said on the Q2 2023 earnings call that it reduced overall capacity growth.
Additionally, a significant portion of its debt is due in the second half of the 2020s. The company announced that it expects total debt to fall to $33 billion by the end of this year. It also anticipates transferring $10 billion in enterprise value from debtholders to shareholders by the end of 2026.
However, given rising interest rates, the company will likely have to refinance much of that debt at higher interest rates, even if it meets its debt-reduction goals. That will probably weigh further on profitability.
Furthermore, CEO Josh Weinstein told Yahoo! Finance in May that he didn’t plan to issue more shares to pay the debt. That solely supports shareholders on the surface, as issuing shares would likely prompt investors to dump the stock.
Nonetheless, investments crowded out by debt-service costs probably reduce the value of the stock. For that reason, debt is likely a limiting factor for Carnival stock, regardless of whether the company issues more shares.
Given the company’s financial challenges, investors should probably avoid Carnival stock. Admittedly, demand is at record levels, and the operational profits mark a significant milestone.
However, its debt remains massive, a limiting factor to getting more cruise ships afloat. Moreover, Carnival will likely have to roll over most of its debt at higher interest rates when it matures, a huge obstacle to profitability and reducing principal.
Ultimately, shareholders have a choice when purchasing investment vehicles. Given Carnival’s situation, investors should choose companies less burdened by debt obligations.
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