Shares in Carnival Corporation (CCL 1.13%) are showing signs of life after a 53% gain so far in 2023. While the company is still down 43% over the last 12 months, the near-term rally is a sign that investors might be becoming more optimistic about its future. That said, the coast is far from clear for this embattled cruise ship operator.
Why is Carnival rallying?
Carnival's 2023 rally has a lot to do with factors outside company control. For starters, falling inflation and relatively mild Federal Reserve rhetoric have convinced many market participants that the U.S. central bank could win its battle against rising prices without tipping the economy into a deep recession. This possible scenario has been dubbed the "soft landing," and it has raised valuations for almost all companies, especially unprofitable ones like Carnival.
For Carnival, lower rates will make it easier to obtain the external financing it needs to survive and expand its operations, while falling inflation could eventually improve margins by lowering the cost of doing business. Furthermore, cruises are consumer discretionary purchases, which aren't necessary for survival. So a soft landing would help Carnival avoid the demand destruction that would occur in a normal recession.
Operations are still in the doldrums
While the macroeconomic outlook is improving, Carnival continues to face company-specific challenges highlighted in its fourth-quarter earnings. Revenue roughly tripled year over year to $3.84 billion, and operating losses narrowed from $1.9 billion to $1.1 billion. But while Carnival enjoyed easy comps against 2021, it still burns through cash at an alarming rate. This is a problem because of its over-leveraged balance sheet.
The company reports $32 billion in long-term debt compared to just $4 billion in cash and equivalents. This money will have to be paid back. And in the meantime, it generates substantial interest expense ($448 million in Q4), which is an additional drag on cash flow.
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Carnival's management is somewhat optimistic for the future. They note that bookings for 2023 are approaching pre-pandemic levels, which means revenue growth could follow (revenue is currently 80% of 2019's Q4). But it could take a long time for these improvements to trickle down to the bottom line. The company expects to lose $750 to $850 million in Q1 2023 alone.
Is Carnival a buy or a sell
While Carnival Corporation's macro outlook is getting better, the company still looks too expensive for what's on offer. While its price-to-sales (P/S) multiple of 1.8 is slightly lower than the S&P 500 average of 2.4, this valuation metric doesn't account for its colossal losses and a seemingly unsustainable mountain of debt on its balance sheet.
While it is possible for Carnival to bounce back over the long term, the risks seem to far outweigh the potential rewards right now, especially if macroeconomic conditions worsen and there is no economic soft landing as widely expected by the market.
