Carnival Cruise Lines (CCL -0.66%) has had quite a momentous week. After releasing its second-quarter earnings last Monday, the stock initially plunged -- only to rebound even stronger and finish the week more than 19% higher. Year to date, the beleaguered cruise line stock is up a staggering 133%.
Of course, Carnival stock still remains 75% below its 2018 all-time highs, and there isn't much chance of getting all the way back there anytime soon. During the pandemic, cruise lines shut down, but since they weren't U.S. companies, they weren't eligible for U.S. bailouts. Therefore, they had to take on tens of billions in debt and sell stock at depressed prices to raise cash.
With a higher share count and triple the debt load, there isn't much chance to regain highs anytime soon. Yet even after this year's more than doubling, there's still room for the stock to run higher -- but how much is feasible?
New management's new plan
Carnival has a new CEO in Josh Weinstein, who took over the role back in August after two years as chief operating officer. On the recent conference call with analysts, management unveiled a new three-year plan geared toward slowing growth, boosting margins, and paying down debt.
At the center of the new plan is management's goal to grow EBITDA per available lower berth day (ALBD) by 50% over today's figures. That may seem like an incredibly steep task, but today's EBITDA per ALBD is still well below 2019 pre-pandemic levels.
While pent-up demand has allowed Carnival to fill out more ships and increase prices, costs have also risen, because of labor, dry-dock costs, and advertising. Yet the trajectory there is already improving; EBITDA per ALBD improved from 59% of 2019 figures in the first quarter to 73% in the second quarter, and they seem to be trending up.
So how is this feasible? Well, management noted that pent-up demand is booming now after the pandemic shock of 2020 and the inflation shock of 2022. In fact, Carnival's booking volumes reached a new record last quarter, 17% higher than 2019, with advanced deposits at a record $7.2 billion. Occupancy is on track to reach 100% this year, and management forecasts low to mid-single-digit price increases per year through 2026.
If the company can keep costs in check, that should continue to boost profits per ALBD.
Image source: Getty Images.
Carnival to begin digging its way back
Under the new plan, management forecasts it will generate about $3 billion in free cash flow annually over the next three years, net of export credits that will help offset new ships coming online. If all goes according to plan, over the next three years, management believes it can pay down another $8 billion in debt.
That seems like a huge amount to pay back, but remember, Carnival's debt tripled as result of the pandemic, from a little more than $11 billion at the end 2019 to over $33 billion today.
Given that cruising demand should remain strong because of post-pandemic "revenge travel" on constrained industry capacity, I'd say it's more likely than not Carnival should be able to raise prices and achieve something close to its deleveraging goals.
Assuming that happens, what would that mean for Carnival's stock price?
Valuation scenarios
Assuming no change in Carnival's enterprise value, at Carnival's current $24 billion market cap, theoretically an $8 billion debt pay-down would lead to a 33% gain in the stock over three years, or roughly 10% per year. That's because the value of the enterprise would shift from the debtholders to the equity holders.
But what of the current enterprise value? And could it rise, or fall?
Some may be surprised that even though Carnival's stock is 75% below its highs and 60% below its pre-pandemic price, Carnival's enterprise value is actually now about 20% higher than it was pre-pandemic:
CCL Enterprise Value data by YCharts
Carnival's enterprise value in the future will be determined by its EBITDA growth, as well as any multiple expansion or contraction.
For EBITDA growth, on the conference call with analysts, one analyst conveniently did the math for us. Based on the company's EBITDA per ALBD expansion target and 2.5% annualized capacity growth, Carnival would earn roughly $6.7 billion in adjusted EBITDA by 2026. That's of course if management hits its operational targets.
That's about 34% higher than its pre-pandemic EBITDA of around $5 billion. So while Carnival's enterprise value is about 20% higher than pre-pandemic today, there could still be a bit of further upside if the company meets its targets.
But wait -- there's more. In the immediate pre-pandemic era, Carnival had actually been trading at a multiyear low valuation. This could have been due to fears over Carnival's leverage, the soft economy at the time, or the belief that Carnival's growth may be limited because of its already-large size. Here's the valuation range over the decade leading up to the pandemic:
CCL EV to EBITDA data by YCharts
While investors shouldn't necessarily count on a higher multiple than the pre-pandemic era, if Carnival's EV/EBITDA multiple does expand from 8 in late 2019 to the average for the prior decade around 11 times EBITDA, that would amount to another 37.5% compounding gain for the stock.
So, if you take the potential 33% gain from the debt paydown, 10% upside from EBITDA growth, and EV/EBITDA multiple expansion from 8 to the average of 11 over the 2010s, that could result in about a doubling in the stock over the next three years.
But are cruise lines worth risk?
Before you dive headlong into the cruise stocks on this thesis, understand the risks. First, the cruises still have a long way to go to achieve higher levels of EBITDA than pre-pandemic, which will require revenue growth, inflationary cost controls, and for the economy to remain strong -- or at least strong enough for people to keep cruising. Cruises are a very cost-effective way to travel, but they are discretionary purchases.
Carnival and its peers are also still heavily indebted, and although leverage can juice returns if everything goes smoothly, it can be disastrous if things turn sour. While the COVID pandemic is now in the rearview mirror, another global pandemic could hit, or another black swan event could disrupt the recovery. If another event were to happen, it could be a fatal blow to the company.
Still, barring another pandemic or sharp recession, there is tantalizing upside in the cruise stocks at this point in the recovery for risk-on investors.
