Cruise stocks such as Carnival Corp. (CORP) surged on Wednesday after Carnival announced its intention to raise on-board and add-on prices. Much ado has been made of the announcement as it signals pricing confidence from a company that has been under pressure during the past few years amid the Covid-19 pandemic.
Many investors believe 2023 could bring a recession. However, Carnival’s price increases convey the company’s confidence that demand for its services will remain strong. Could the company’s bullish outlook provide an inflection point for its stock?
Price increases
Carnival says it will raise gratuities by $1.50 in the new year, applying to both standard rooms and suites. Additionally, Carnival’s revenue growth strategy includes a $1.70 hike in daily wi-fi rates, which eclipses the current U.S. inflation rate by nearly 3%.
Carnival’s integrated business model provides it with economies of scope, allowing it to optimize its revenue streams. The company’s 48.30% broad-based market share enables it to exercise economies of scale, thus granting the company pricing power over its competitors and bargaining power over its suppliers.
As most investors are aware, Carnival’s operations were disrupted during the past two years due to the pandemic and subsequent balance sheet restructuring processes. However, with the populations of many countries, especially the U.S., no longer being concerned with Covid, I believe the company could easily scale back to its historical gross profit margin midpoint of 36.2% despite the extra weight of extreme debt levels the company has taken on in recent years. Moreover, if economic growth is sustained, the cruise liner’s operating margin midpoint of 13.45% could be possible, providing investors with lucrative residual value prospects.
Operational review
Carnival made a strong showing in its fourth fiscal quarter, revealing a sharp year-over-year recovery. On an accrual basis, Carnival’s revenue surged by 198.29% since the previous year and its earnings per share beat analysts’ consensus by 4 cents.
During the past year, the company completed a monumental turnaround strategy, proven by its resurfacing of 90 vessels, rehiring of 100,000 crew members and the addition of eight private island charter routes. Furthermore, Carnival’s current occupancy is at 99% of its pre-pandemic level, with its revenue per passenger being 2% higher than in 2019.
Carnival managed to reduce its cost basis from a 25% increase in this year’s first quarter to 11% in its most recently reported quarter. The company’s cost-basis management is a significant achievement, considering exacerbated fuel costs and wage demands in 2022.
With a global inflation pivot, the cruise line industry’s costs are likely to recede, which could allow Carnival to regain profitability.
The company’s CEO, Josh Weinstein, elaborated on the above-mentioned factors during the company’s latest earnings call. According to Weinstein:
“We believe we are accelerating our return to strong profitability through our fleet and brand portfolio management which is delivering prudent capacity growth weighted toward our highest returning brands and amplified by nearly a quarter of our fleet consisting of newly delivered vessels. We believe this leaves us well positioned to drive revenue growth across our global brand portfolio as we continue to leverage our scale on our industry-leading cost base to deliver free cash flow, which over time will propel us on the path to deleveraging, investment-grade credit ratings and higher ROIC.”
Carnival’s current return on invested capital (ROIC) is at a deficit to its weighted average cost of capital (WACC). However, retrospective results indicate that the company’s ROIC has usually exceeded its WACC in the past, which could again be the case once its pandemic recovery is fully complete.
A superior return on invested capital is associated with the efficient use of working capital and adequate return on shareholders’ risk-return utility. Thus, Carnival’s stock could surge if it re-established an ROIC-WACC surplus.
Valuation and momentum
Carnival’s valuation metrics are on solid ground despite its recently incurred systemic and idiosyncratic challenges. The enterprise-value-to-Ebitda ratio measures a company’s capital structure profitability, providing information on its operational resilience. In addition, the metric phases out depreciation and amortization, which are often subjective income statement line items. Juxtaposing Carnival’s current enterprise-value-to-Ebitda ratio of -19.68 with its forward enterprise-value-to-Ebitda ratio of 9.37 illustrates that analysts predict the company is on a fast track to value creation.
Furthermore, Carnival’s post-capital structure valuation is nearing its midpoint, with its forward price-earnings ratio at 25.5. The company will probably restructure its financing as its operations continue to improve, which could compress its price-earnings ratio, in turn lending investors a value gap.
Lastly, the stock has entered a momentum trend over the past two weeks, which developed shortly after the company’s fourth-quarter earnings beat. Short-term momentum is often a key indicator of a pending mean reversion, and it’s an anomaly that I highly regard.
Final word
I believe Carnival’s stock could be one of the primary breadwinners in 2023 as the company’s turnaround program has started bearing fruit. The factors described above suggest that key metrics are beginning to align for a potential stock price recovery, which could see the stock present a value gap in due course.
This article first appeared on GuruFocus.