Carnival – strong second quarter sees full year upgrade

Carnival’s second-quarter revenue increased by 18% to $5.8bn, driven by an uplift in both ticket sales, and onboard and other revenue.

Underlying cash profit (EBITDA) was up 75% to $1.2bn, beating guidance by around 14%. The uplift reflected strong pricing and prudent cost control.

Underlying free cash flow of $1.3bn, reflected the improved operational performance. Net debt at the period end was $27.7bn.

Carnival saw record bookings in terms of both price and occupancy, and has increased its EBITDA guidance for the full year to from $5.6bn to $5.8bn.

The shares were up 6.1% in afternoon trading.

Our view

Carnival’s record second quarter results and improved full year outlook have impressed the market. However, with a debt mountain still to climb, it’s perhaps the positive early signs for next year that are the most encouraging. But cruising can be a fickle business. So far Carnival’s navigated the conflict in the Red Sea and the closure of its Baltimore with aplomb. But investors need to be aware that the industry can be particularly susceptible to a sudden change in fortunes.

The key question is how long will strong demand last? Much will depend on policy makers' ability to guide the economy towards a soft landing on both sides of the Atlantic as inflation starts to ebb. And here there's still a lot of uncertainty. But the demographics of cruise passengers may provide some shelter from the storm should we see an economic slowdown. The cruise industry’s customer base tends to be dominated by the over fifties. And there are some signs that consumer spending is holding up better amongst older generations.

Carnival is expanding its fleet slower than it has in the past, and we support this more cautious approach. The moderating inflation environment gives the company some headroom for promotional activity should the demand outlook soften. Meanwhile ongoing moves to harmonise its brands also have the potential to enhance profitability.

But our biggest concern is the balance sheet which is still feeling the after-effects of the COVID-19 pandemic. Net debt currently stands at $27.7bn, which is higher than Carnival's total market value, meaning that for now, it's very much debt holders who influence Carnival's course. Although the outlook for cash generation is encouraging, it could be a long while before that balance is redressed in shareholders' favour.

Despite the recent strong performance, the equity valuation remains a long way below the long-term average. Carnival is well-placed to have a good year, but it needs to have a few in a row to make a dent in its debt pile. And with consumers under pressure from all angles, that could still be a big ask. Net debt is sitting at about 5x this year's EBITDA guidance. That's very high. Until it returns towards a low single-digit figure, there's unlikely to be a return of dividend payments to smooth investment returns. The high level of indebtedness means there's pressure for management to deliver, which increases the risk of ups and downs.

Environmental, social and governance (ESG) risk

Consumer services companies are medium-risk in terms of ESG, and very few companies are excelling at managing them. That leaves plenty of opportunity for forward-thinking firms. The primary risk-driver is product governance. The impact of their products on society, labour relations and environmental concerns are also key risks to monitor.

According to Sustainalytics, the company's overall management of material ESG issues is strong, with a robust governance structure and reporting framework in place. However, Carnival still faces significant exposure to risks linked to emissions, effluents and waste as well as quality and safety issues. Carnival has implemented carbon reduction programmes but shipping is likely to be one of the last forms of transport to be decarbonised.