- We invested in Carnival shares back in January, and the stock has now reached the high-end of my target price.
- The best is yet to come for Carnival from a financial performance perspective, but the risk-reward profile is no longer attractive for value investors.
- My investment thesis for Carnival was based on three pillars and an evaluation of the current state of these three factors confirms Carnival is now richly valued.
- This idea was discussed in more depth with members of my private investing community, Leads From Gurus. Learn More »
Important: This article was originally published for members of Leads From Gurus on April 8, 2021. All data is as of April 8.
Our value portfolio is fully invested in stocks at the moment, which I believe is something our members are aware of. It would have been easy for me to increase the size of the portfolio to make way for new stocks, but I wanted to challenge myself by limiting the size of the portfolio as it would force me to liquidate existing positions to make way for new ones. This, I believe, will help me make better investment decisions.
Carnival Corporation (NYSE:CCL) has been part of our value portfolio since the beginning of the year when the portfolio was established. Our cost basis is $21.72 per share, and at the current market price of $29, we're sitting on a return of 33.52%. Yesterday, Carnival shares reached a 52-week high of $30.63, and that's when I thought it could be time for us to move our funds away from Carnival. Although we could have realized a higher profit if we exited the position yesterday, I wanted to double check the company fundamentals before publishing this article (I own Carnival shares in my personal portfolio as well and I will sell the shares after publishing this article).
Why are we selling Carnival when the best is supposedly yet to come?
Before I answer this question, let me lay out an important fact. Booking our profits does not mean that I believe Carnival shares will immediately plummet. There's a small probability, in my opinion, for Carnival shares to reach new highs from this point given the strong momentum behind travel and leisure sector stocks. That said, I believe my thesis has fully played out, and that shares are no longer cheap.
My investment thesis for Carnival was based on a few assumptions.
- Carnival shares might have been undervalued even before COVID-19 wreaked havoc.
- Stock markets are forward-looking, meaning Carnival shares will and should recover in the market before its financial performance does.
- There's massive pent-up demand for travel, which should lead to strong booking growth once the vaccination program becomes successful.
Let's evaluate the current state of these assumptions to get an understanding of the valuation of Carnival today.
First, Carnival shares have been on a tear in the last 12 months, appreciating more than 180%. If you only look at the market price of Carnival shares, you might feel a false sense of security that the stock is still well below its pandemic highs. In mid January last year, Carnival stock was trading well above $50, which suggests the stock is still close to 50% below where it was before the pandemic. This, however, is not accurate. In February 2020, there were about 680 million Carnival shares outstanding, and today Carnival has more than 980 million shares outstanding. Carnival, as many of you must be aware, issued new equity regularly to improve its liquidity position in a bid to remain solvent until business conditions improve. A quick look at the market capitalization of Carnival confirms the company has almost fully recovered to its pre-pandemic valuation level.
Exhibit 1: Carnival Corporation market capitalization
Carnival might have been undervalued before the pandemic, which suggests there could be more upside to the stock. However, I do not want to remain invested when my thesis is hanging by the thread.
Second, Carnival shares already have reacted to the reopening of the economy, and I believe most of the positive factors are already baked into its stock price today. The CDC did not extend the "no sail order" when it lapsed on Sept. 30, 2020, and this marked the beginning of a notable improvement in the sentiment toward cruise operators including Carnival. The liquidity position of Carnival, on the other hand, has continued to improve on the back of new equity and debt issuance. This is also correctly priced in the market today. The success of the vaccination program is the other remaining factor, and I believe this is also correctly priced in as investor focus has now shifted to the reopening phase of the economy, not the chaos created by COVID-19.
Third, Carnival reported strong booking volumes yesterday when the company reported first quarter earnings. Looking at the numbers, it's difficult for me to see how bookings can improve meaningfully from the current level. According to data from company filings, bookings for 2022 already are ahead of 2019, which was one of the best years in the company's history. Cruise prices for 2022 also are higher than what they were in 2019. There's no arguing with the fact that these bookings trends indicate strong earnings growth by 2022, but I believe we now know nothing that the market does not. In other words, I believe Carnival stock price has already reacted to this new information as it's publicly available to all investors alike. Because our investment strategy is based on identifying earnings surprises, I believe Carnival is not the ideal stock for us to remain invested in given that the market is already aware of the strong bookings growth.
Based on how micro and macroeconomic factors have played out ever since we included Carnival in our value portfolio, I believe our thesis has fully played out, and that the risk-reward profile is no longer favorable.
We will be booking our gains from Carnival when the market opens for trading today. This decision was taken based on how the thesis has so far played out. I could be prematurely selling Carnival, but I believe it's the right thing to do considering how I do not see any new catalyst that could help the stock in the foreseeable future.
One other factor that played a part in this decision is the overvalued nature of the stock market. Rather than holding richly-valued companies that are in the thick of things, I prefer to diversify our portfolios into undercovered, undervalued stocks.
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This article was written by
Analyst’s 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.
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