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Carnival Corp: Recovering a Damaged Image

April 29, 2014 | About:
Patricio Kehoe

Patricio Kehoe

7 followers

In the last article I wrote about Carnival Corporation (CCL) my outlook was rather positive, despite the negative brand perception that the cruise operator gained after its 2012 and 2013 debacles on the sea. And for the most part, I remain confident in this firm’s long-term future profitability, given its competitive advantages on several fronts and 50% market share (shared with its only rival Royal Caribbean Cruises Ltd. (RCL)) in the global cruise industry. However, while investment gurus like Arnold Schneider (Trades, Portfolio) and Sarah Ketterer (Trades, Portfolio) are buying Carnival shares in the hopes of earning solid profits, short-term earnings remain an issue for the company as customers are yet to recover fully from 2013’s negative brand image. So, what can we expect looking forward?

Changes to Boost Profits

With Arnold Donald as Carnival’s new CEO, the company has been facing its issues regarding safety measures in the hopes of recovering its brand image, especially in the cases of the Concordia and Triumph brands, which suffered severely after their accidents at bay last year. And while revenue is still down from 2011’s peak $15.8 billion, 2013 showed some recovery, sporting a 3.4% growth rate, consequence of the cheaper prices implemented since 2012.

However, investors shouldn’t worry too much about this factor, as management plans to increase prices over the next years and customers are likely to adjust given the large supply and demand gap in the cruise industry (cruise industry capacity grows at 3%, while the 65 and older demographic will increase by over 16% between 2015 and 2020). Furthermore, the company’s efforts to reduce accidents in the future is well on its way, having invested $700 million in upgrading its engine-room designs and firefighting equipment, as well as hiring maritime experts to review the current safety protocols.

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Nevertheless, investors looking for short-term profit gains should look the other way, as Carnival’s growth is likely to only take off substantially after 2015, once prices increase and the firm deploys four new ships to destinations in Asia and Latin America.

However, I believe the long term will be prosperous for this cruise operator, since its scale advantage will allow it to leverage port commissions, overhead costs and maintenance efficiencies across its entire fleet of ships. Moreover, as the domestic and European economic environment improves, so should discretionary spending amongst middle class consumers. And while 2014 won’t show significant growth, 2015 will likely paint a different picture, with the current 8.75% operating margin and 4.39% return on equity expanding substantially to 16% and 10%, respectively.

Future Outlook

Looking forward, Carnival is expected to reach an occupancy rate of 105%, while capacity growth will remain under 5% throughout 2016, in line with the average 5% annual growth rate for the cruise industry. Pricing however will grow in the low single-digit range over the next few years, with 1% estimated for 2014. And while 2013 showed a bump in debt levels, which grew by nearly $1 billion since 2012, the company’s free cash flow also increased, closing the fiscal year at $685 million.

Nonetheless, Carnival’s scale advantage and leveraging of costs should help level out these results in the long term, while maintaining its current above-average 2.6% dividend yield. Given the company’s short-term prospects, I believe investors should hold on buying shares at the moment, as the company’s stock is trading at 28.9x trailing earnings, compared to the 21.4x industry average, making it somewhat overvalued. However, I remain bullish that profits will pick up after 2015.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

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