Carnival's (NYSE: CCL) business was doing well prior to the onset of the pandemic. The public health crisis dealt a blow to the industry, but things are starting to pick up in a big way.
Investors are taking notice. Shares are up 85% just in the past 12 months. However, they remain 76% below their peak price.
As we take a closer look at this cruise line stock, there's one clear reason investors should buy it like there's no tomorrow. However, there is also one must-know factor that will cause you to avoid Carnival shares like the plague.
Reason to buy: strong demand
You'd struggle to find an industry or a company that was harder hit by the coronavirus pandemic. Spending days on a single vessel in close proximity to many other people was probably the worst thing someone could do under the circumstances. As a result, Carnival had to temporarily halt operations. Revenue cratered 73% in fiscal 2020 and 66% in fiscal 2021.
But the industry is bouncing back. In fiscal 2023 (ended Nov. 30), Carnival reported that revenue increased 77% year over year to $21.6 billion. That's an all-time high. And customer deposits of $6.4 billion were a Q4 record. It's clear that consumer demand for cruise trips is back in full force.
"We entered the year with the best booked position we have ever seen, and now have nearly two-thirds of our occupancy already on the books for 2024, at considerably higher prices," CEO Josh Weinstein said.
This coincides with the fact that retailers are highlighting consumers' inclination to spend more on experiences, as opposed to physical things. This is all welcome news for shareholders.
Wall Street is also optimistic. Consensus analyst estimates call for revenue to rise at a compound annual rate of 6.8% between fiscal 2023 and fiscal 2026. While forecasts should always be taken with a grain of salt, this is a clear indication of the optimism the market has about the direction of Carnival's business. The momentum is a key reason to scoop up the stock right now.
Reason to sell: high debt
Despite robust demand trends, Carnival is still a risky company to own. As of Nov. 30, the business had more than $30 billion of long-term debt on the balance sheet. That's compared to its entire market cap of $21 billion.
With operations screeching to a halt during the pandemic, Carnival was forced to tap capital markets for fresh cash. To its credit, it was able to reduce the debt balance by $4.6 billion in the past 12 months. That's possible due to the company generating positive adjusted free cash flow. But there's a lot of work left to get the balance sheet to pre-pandemic levels.
Investors should always think twice before buying a business with a sizable debt burden. For starters, Carnival paid $2.1 billion in interest expense in fiscal 2023, which exceeded its total operating income. This creates a financially unstable company that is still struggling to get back to profitability.
As a result, Carnival is even more sensitive to macroeconomic factors. Demand for travel is already dependent on the state of the economy. In this case, should there be a recession on the horizon, not only is it probable that the business will see weaker demand, but Carnival might have problems making its debt payments. The last thing shareholders would want is another external capital raise.
In my opinion, Carnival's current financial situation carries more weight than the company's strong demand, so I'm avoiding the stock.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool recommends Carnival Corp. The Motley Fool has a disclosure policy.
