One of the industries that suffered the most during the early stages of the pandemic was cruising. For months, these companies couldn't sail their ships. And that meant earnings plummeted. Carnival (CCL -1.03%) (CUK -1.37%), the world's biggest cruise ship operator, shifted from healthy profits to a loss -- and debt ballooned.
But in recent times, things have been looking up for the company. Demand has nearly returned to pre-pandemic levels. And the company is on its way back to profitability. Still, debt remains high. And today's rising interest rate environment makes variable-rate borrowings even more costly. Considering the full picture, is it time to buy, sell, or hold Carnival stock? Let's find out.
Earnings fell, debt rose
First, a little background on Carnival's situation since the first days of the pandemic. As previously mentioned, the company halted cruising operations in the earlier stages of the health crisis, and as a result, earnings plummeted. The company took on more debt to keep itself going until the situation improved.
CCL Net Income (Annual) data by YCharts.
Finally, after more than a year of ships anchored, Carnival set sail again. Since that time, Carnival has progressively demonstrated improvements in earnings and demand for its cruises. The most recent earnings report is particularly encouraging.
In the first quarter of this year, the company's net loss on the basis of generally accepted accounting principles (GAAP) came in lower than expected -- at $693 million instead of the forecast range of $750 million to $850 million. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) reached $383 million and beat the company's guidance.
Even better, Carnival offered clear signs of demand for its cruises. The company reported record booking volumes. And total customer deposits reached their highest ever for a first quarter. This signals travelers have returned to cruising. They're not bothered by higher prices, and Carnival is also seeing strong onboard spending.
Of course, the one big problem now is Carnival's debt level. The company had some positive news on this point. In Q1, cash from operations turned positive. Carnival expects this to continue. And this cash from operations will progressively pay down debt. This is absolutely something to cheer about. The company also said it ended the recent quarter with more than $8 billion in liquidity. And that's another positive point.
Still, Carnival won't be able to pay off its massive load of debt overnight. And any variable-rate borrowings could lead to higher costs in a rising interest rate environment. The debt-to-equity ratio, which indicates how much a company relies on borrowings, has soared over the past two years. This indicates that risk, too, has increased.
CCL Debt to Equity Ratio data by YCharts.
Shares are rebounding
Now let's take a look at the stock price. Carnival shares have rebounded nearly 40% this year. That's after falling 84% over the previous three years. But back when the shares were trading at a much higher level, the company was comfortably profitable, and debt was much lower than today's level. So I wouldn't expect Carnival shares to return to those levels any time soon.
In terms of valuation, Carnival is trading close to its lowest ever in relation to sales. This looks like a reasonable price to pay for the stock now, considering a rebound in cruising and Carnival's leadership in the market.
Returning to the original question of whether you should buy, sell, or hold Carnival, that depends on your comfort with risk. If you're a cautious investor, you're probably better off choosing a company with less of a reliance on borrowings. It may take Carnival some time to return to the financial health of pre-coronavirus days.
But if you're an investor who doesn't mind a bit of risk and a bit of volatility in share price, Carnival is a great stock to buy and hold right now. It may not be smooth sailing just yet. But the company has offered plenty of signs that better days for earnings and potentially share-price performance may be on the horizon.
