When Carnival (CCL -0.66%) reported third-quarter 2023 earnings it was happy to note that it had record-level performance in some key metrics. So, in many ways, its business isn't just back to pre-pandemic levels, but exceeding them. Yet, unlike peer Royal Caribbean (RCL 2.27%), Carnival's stock hasn't recovered anywhere near pre-pandemic levels. Here's one important factor that helps explain the situation and something that investors should monitor.
Carnival's big advance isn't big enough
Carnival's stock price is up some 60% over the past year. That's a huge price increase in a very short period, but the shares are still off by roughly two-thirds from where they started in 2020 before the coronavirus pandemic hit. By comparison, Royal Caribbean is up 90% over the past year and has clawed back to within striking distance of its pre-pandemic level, down just 9% or so from where it started in 2020.
And yet, Carnival had some very good news to report when it issued third-quarter 2023 earnings. The news included:
- Record Q3 revenue.
- Total customer deposits hit a third-quarter record of $6.3 billion.
- Advanced bookings for the full year 2024 go well above the high end of the historical range.
- The advanced bookings were made at higher prices (in constant currency) than 2023 levels.
Some of this news is cruise industry hype, but the big takeaway is that Carnival's business is doing very well right now. Given the strength of its advanced bookings, it looks likely that Carnival's success will continue into 2024.
So why is its stock still trading so far below pre-pandemic levels? And why has it lagged so far behind a peer like Royal Caribbean? One very big reason is leverage.
Carnival has more work to do on its balance sheet
When the coronavirus pandemic was in its early stages, countries around the world shut non-essential businesses. That included cruise lines. When the restrictions were eased, customers didn't exactly flock back right away. With limited revenue, cruise lines had to raise capital to cover the costs they still had to pay. Carnival's debt-to-equity level was around 0.45 times coming into 2020, which is a completely reasonable figure. In fact, it was perhaps conservative relative to Royal Caribbean, which sat at around 0.9 times.
But then things dramatically changed. By the middle of 2023, Carnival's debt-to-equity level had risen to more than 5.7 times equity. That's a shocking increase and suggests that Carnival's balance sheet is highly leveraged. In fairness, Royal Caribbean's debt-to-equity ratio at that point was even higher, at around 6 times, but there's an important difference. Royal Caribbean's leverage was coming down more quickly, having peaked at around 8 times. At that point, Carnival's leverage was still on the rise.
CCL Debt to Equity Ratio data by YCharts
Fast-forward to the third quarter and Carnival's debt-to-equity ratio has now started to come down. But Royal Caribbean's is dropping as well. They are now roughly similar, showing that Royal Caribbean is still reducing debt with more urgency than Carnival. That's probably the right call, given the cyclical nature of the cruise industry. Indeed, if there's a recession, demand for cruises is probably going to decline and then both companies may need to lean on their balance sheets again to keep their respective fleets afloat.
Now add in the fact that Royal Caribbean's earnings were strongly in the black in the third quarter while Carnival's earnings have been hovering around breakeven. If there's a downturn in the cruise industry, Carnival looks like it would be in a much weaker position than its peer.
Watch Carnival's balance sheet
Leverage can be very useful, especially in an industry that requires massive capital investments, like buying cruise ships. But leverage can also be very dangerous if a company finds itself facing a period of weak earnings. Simply put, Carnival's balance sheet was in much better shape prior to the pandemic than it is now. That means the business could be less resilient when the next headwind arrives. Leverage probably needs to come down a lot further before investors get more comfortable with Carnival.
