Down 67% year to date, Carnival Corporation (CCL -1.85%) has probably landed on some value investors' radar. But a cheap stock doesn't always mean a good deal. Let's discuss three red flags that could make the cruise company underperform over the long term.
1. The massive debt load
Like most cruise companies, Carnival was hurt by the COVID-19 pandemic, especially after the U.S. Centers for Disease Control's (CDC) no-sail order scuttled its operations for much of 2020. To survive the crisis, management turned to debt markets.
As of the third quarter, Carnival reports $28.5 billion in long-term debt -- up from just $9.7 billion at the end of 2019. The leverage will be a long-term drag on cash flow and earnings because debt generates interest expense and has to be repaid.
Image source: Getty Images.
Recent results are also a mixed bag. While third-quarter revenue jumped 688% year over year to $4.3 billion because of easy comps against the prior year, the company's operating loss of $279 million (compared to interest expense of $422 million) means it is still struggling to deal with its mountain of debt.
2. Macroeconomic headwinds
Carnival's precarious debt situation also exposes it to macroeconomic headwinds. The U.S.' annual inflation rate stands at 8.2% as of September. And the inflation reflects higher energy and material costs, which erode Carnival's margins and make profitability harder to attain.
For a debt-laden business like Carnival, rising interest rates are another challenge because they could increase the interest payments on its variable-rate loans and make refinancing more expensive. Higher rates could also push the global economy into recession, which would bring Carnival into another consumer demand-related crisis before it recovers from the previous one.
3. Better alternatives
The entire cruise industry faces similar problems with debt and operational losses from the COVID-19 pandemic. But Carnival seems to have emerged from the crisis in a weaker position than its rival Royal Caribbean, (RCL -2.20%) which has "only" fallen 45% since the start of the year compared to Carnival's decline of 67% in the same period. Royal Caribbean's outperformance might have something to do with its guidance.
Unlike Carnival, which reported a net loss of $0.65 per share in the third quarter, Royal Caribbean expects to swing to profitability -- guiding for earnings per share (EPS) of between $0.05 and $0.25 in the period.
The rival company also expects adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $700 million to $750 million compared to Carnival's $300 million. Plus, its balance sheet is significantly less leveraged, with just $17.7 billion in long-term debt, compared to Carnival's whopping $28.52 billion.
With a price-to-sales (P/S) multiple of just 0.87, Carnival stock's valuation is much lower than Royal Caribbean's stock, which trades for 2.47 times sales. But with significantly worse financial metrics, the cheap shares don't necessarily mean a good deal.
Avoid Carnival Corporation
Carnival Corporation faces a triple threat of massive debt, worsening macroeconomic conditions, and financially healthier rivals. And these headwinds could cause shares to underperform over the long term, so investors should probably avoid the stock.
