Up 30% year to date, Carnival (CCL -2.96%) is one of many battered stocks benefitting from a resurgence in 2023. But will it last? While there are some bullish signs for the cruise industry, Carnival's weak operating cash flow and overleveraged balance sheet could stop the rally. 

What is behind Carnival's rally?

Carnival wasn't the only company to start the new year on good footing. In fact, the Nasdaq Composite index (which currently holds many of the market's most beaten-down tech stocks) rose by 6.4% on average. Investors are optimistic that lower inflation will encourage the Federal Reserve to slow its interest rate hikes without tipping the economy into a severe recession. Carnival is also enjoying company-specific tailwinds. 

In the fourth quarter of 2022, Carnival and its peers relaxed most of their remaining COVID-19 restrictions, no longer requiring proof of vaccine or testing for trips of 15 nights or less. The move brings the cruise industry in line with land-based vacation alternatives like hotels, amusement parks, and resorts. And the changes will help Carnival close the gap with its pre-pandemic 2019 performance. 

Carnival's business is booming 

Carnival's fourth-quarter results showed continued recovery as COVID-related headwinds ease. Sales roughly tripled to $3.84 billion. But while that's nothing to shake a stick at, it's significantly below the $4.8 billion reported this time in 2019. Analysts disagree about when the industry will return to pre-pandemic levels. 

Market research company Euromonitor doesn't expect cruise industry revenue to fully recover until 2027 because of lingering weakness in Europe and Asia. Truist equity analyst Patrick Scholes strikes a distinctly more bullish tone, with his research indicating the industry's first-quarter sales have already jumped a staggering 50% compared to 2019. 

A cruise ship.

Image source: Getty Images.

Carnival's management corroborates Scholes' optimistic outlook. It reports that 2023 bookings are already higher than in 2019, which could lead to higher passenger volume. This is welcome news because the company will need to dramatically improve its operating results to stay afloat.

In full-year 2022, the company generated an operating loss of roughly $4.4 billion, making it hard to service its $40 billion in long-term debt. Not only will the debt have to be repaid, but it also generates interest expense, which totaled $1.6 billion in the period. 

The valuation is still too high 

With revenue soaring back to pre-crisis levels and a seemingly low market cap of just $13.6 billion, Carnival stock looks cheap on the surface. Those numbers give it a price-to-sales (P/S) multiple of just over 1, which is less than half the S&P 500 average of 2.3. But when you buy a company, you also buy its debt -- a fact highlighted by a metric called enterprise value (EV), which combines net debt with market cap. 

With an EV of $45 billion, Carnival's valuation is not materially lower than it was at some points in January 2019 -- a time when it had more revenue, more profit, and a stronger balance sheet. That looks like far too much to pay for a company that is still yet to fully recover.