Carnival Cruise Line (CCL)(CUK) is the largest company in the cruise industry and together with Royal Caribbean Cruises (RCL), and Norwegian Cruise Line (NCLH) controls about 90% of the American market. Despite RCL’s fast growth in recent years, Carnival's 100+ ships and 200,000+ passengers’ capacity still accounts for half the total’s currently in the market. On paper, there’s a lot to like in Carnival’s impressive numbers. The considerable fleet size helps the company to capitalize on its efficient scale and achieve a cost advantage. Carnival in recent years has generally earned consistent returns on equity, and capital and management have allocated investor’s money in a disciplined fashion. For all the mentioned reasons I have held a small position in the stock and enjoyed the ~4% yield, but several red flags are now lining up and convinced me to move on to greener pastures. I encourage readers to do the same.
Even what it seems just a pebble in your shoe can quickly deliver real pain.
Ill-fated Costa Concordia, a Carnival cruise ship.
Short-term outlook worsening
As a long-term shareholder, I usually try not to pay too much attention to the news. Over the long run, cash flow trumps just about everything else and Carnival is the market leader in a relatively stable business. Cruise lines relative under-penetration of the market and tailwind of an aging world population provide support for a continuous top-line growth of about 4% that all the three top players have achieved in recent years. However, the story is quite different when it comes to margins and bottom line. In March, Carnival’s management has revised downward its guidance for FY19 to EPS of $4.45 at midpoint. This revision was necessary (from previously expected EPS of $4.65 at midpoint) to account for EPS 0.22 in forex headwinds and higher fuel costs. Will it be the time for another adjustment now that the U.S. State Department restricted cruise line trips to Cuba? Analysts predict the ban will have a noticeable impact on the EPS and some even chipped in a downgrade (on Norwegian) sending down the stocks of all three players. Royal Caribbean has estimated a ~3% impact on earnings: the same impact on Carnival would account for roughly $0.15 EPS, out of the lower end of the range provided in March ($4.35). The chances are high that more disappointments are on the way for Carnival’s investors. Shares may look inexpensive today from a fundamental standpoint, but they might get even cheaper soon.
No more dividend hikes?
Carnival hasn’t been a traditional DGI name: the company cut its dividend in the aftermath of the 2007-2008 crisis, but it has been quick in turn itself around and restoring it after. After a moderate, stable payout in the 2010-2014 period, in the more recent years, Carnival pushed to present itself as a dividend growth story and doubled shareholders’ distributions in the period 2014-2019.
However, the dividend growth story quickly fizzled this year as Carnival decided to stop the hikes and concentrate on buybacks. CEO’s Arnold Donald instilled so much confidence to deliver strong EPS growth this year that the words “double-digit earnings” and “double-digit return” showed up combined more than ten times in the last conference call. Nevertheless, such enthusiasm somehow strides with the provided midpoint guidance, which is now less than 5% higher last year’s adjusted EPS. Again, this was before the Cuba travel restrictions. What is going to happen once the company factors this new impact as well?
Show me the value
For those who still think they can endure the short-term headwinds as the company trades at attractive multiples, I encourage them to look around: they could shop for the competition as well.
Carnival might have the highest yield among the three top cruise liners, but considering it is not a suitable choice for DGI investors, then either Norwegian or Royal Caribbean have high chances to deliver similar or even better total returns. On an EV/EBITDA basis, Norwegian is the player currently showing the largest discount versus its five years average (9x vs. 14x). It is also the one with the most substantial difference between the actual price and consensus target, reflecting an almost 30% gap. And if Norwegian is the most “value” name, as expected Royal Caribbean should be a “growth” investor's favorite name as it is the only player showing a “double-digit” earnings growth.
If the presented economics are not enough of a motive to sell your shares, Carnival has given investors an even more important reason to stay away. In 2017, Carnival was ordered to pay a $40 million fine (the so-called “cost of doing business”) for illegally dumping contaminated oil waste in the oceans and falsifying logs to hide its actions. A few days ago, Carnival was ordered to pay yet another $20 million for violating its probation period and continuing unabated to dump plastic, sewage, oil, and food waste.
The company pleaded guilty and again promised to stop the awful practice. Is it believable they are going to stop this time, even if it is not the most practical course of action? After all, management already clearly demonstrated they think of social responsibility as nothing but a nuisance. And when considering the consequences so far, Carnival could be better off setting aside another $20 million for the next likely fine in 2021. Maybe someone will be satisfied for Carnival being so cost-efficient!
I am not buying into a company due to management concerns and a focus on short-term profits. Maybe, once the oceans turn into sewage and nobody will go cruise anymore, Carnival will realize that waste compliance was something quite valuable over the long-term. As U.S. district judge Patricia Seitz reportedly reminded Donald: "If you all did not have the environment, you would have nothing to sell." The cost of doing business for Carnival should be keeping the seas as clean as possible. Some readers might think this is so far into the future to be irrelevant, but I’d argue that they are wrong: reports are coming in from all over the world this year that marine life is already dying because of plastic mistakenly taken for food and eaten. Humans can only see the top of the iceberg as whales are being found dead on the shores with kilos of plastic in their stomachs. However, it doesn’t take nearly as much to kill sardines and herrings, which like whales feed on zooplankton.
So, while Carnival executives have once again pleaded to stop polluting the oceans, the proof of the pudding is in the eating: until the evidence comes in that Carnival has taken a U-turn and stop dumping garbage in the oceans, I am just glad and feel good with myself I’ve dumped all my Carnival shares.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.