With shares down by roughly 16% year to date, Carnival Corporation's (CCL +0.41%) recovery story has hit some choppy waters. While business has been booming in the half-decade following the COVID-19 pandemic, investors and analysts are now worried about a new crisis: the Iran war, which has already led to a sharp increase in global energy costs.
Let's weigh the pros and cons of Carnival Corporation stock to see how it might navigate these latest challenges and determine what the next three years might have in store for the company.
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Business is booming, but the pandemic left deep scars
Carnival's stock still trades at a steep discount to its all-time high of $65.91 (reached in January 2018). And that isn't surprising, considering the cruise industry was one of the worst affected by the pandemic. The crisis led to years of shuttered operations and ballooning debt as management had to borrow money to pay staff and keep the ships seaworthy despite not being able to carry paying customers.
The good news is that Carnival has totally bounced back from an operational perspective. The company's fiscal first-quarter results were a slam-dunk success, with revenue increasing 6.1% year over year to $6.2 billion, driven by record passenger ticket sales and an increase in onboard revenue -- a metric that refers to sales (such as food and drink) made on voyages. The company's bottom line is also rapidly improving, with first-quarter operating income jumping 11.8% to $607 million.
NYSE: CCL
Key Data Points
That said, the situation isn't all peaches and cream. Carnival is still a long way away from paying off its pandemic-era debt, which currently stands at $23.8 billion. This over-leveraging is probably the main reason why the stock remains stagnant, despite the company's operational momentum.
The debt repayments eat away at Carnival's cash flow while also generating a large amount of interest expense ($291 million in the first quarter alone), which directly reduces the amount of earnings left over to return to investors through buybacks or dividends. Carnival's high debt levels also make it more vulnerable to future economic crises.
Energy costs: The next crisis?
In late February, the U.S. and Israel began strikes on Iran, a nation responsible for roughly 4% of global oil production. The Islamic Republic has responded by blocking the Strait of Hormuz, a transit point for shipments out of the Persian Gulf to Asian markets. Oil futures have surged by more than 94% year to date in response to the crisis. And this is relevant for cruise companies because their ships run on a petroleum product called bunker fuel, which tends to track the oil market.
Carnival spent $397 million on fuel in the first quarter. This outflow might seem like a small fraction (roughly 6.4%) of its total revenue. Still, if this number rises substantially, it could have a significant impact on the company's margins and dramatically reduce profits.
Furthermore, unlike its rival Royal Caribbean, Carnival didn't report the use of hedging to limit fuel cost volatility. This means investors should expect the negative impacts of the Iran war to show up in the company's income statements relatively quickly.
Perhaps more importantly, the war in Iran could spike global inflation, which could hurt consumer purchasing power and encourage the Federal Reserve to delay lowering rates. As a highly leveraged company, Carnival will want interest rates to come down because that makes it easier for management to refinance its mountain of debt on more favorable terms.
What will the next three years have in store?
Carnival isn't a bad company. Its cruise business continues to grow at an impressive rate while margins and profits remain healthy. That said, it may once again become the victim of macroeconomic factors outside management's control. Rising fuel costs and the possibility of another inflation crisis threaten to derail its recovery. Investors should sit on the sidelines for now.
