We recently upgraded our rating on Carnival Corporation (CCL) from Underperform to Neutral. The rating was upgraded mainly accounting for the benefits of seasonality.
Other factors that encouraged us to lift our rating were solid pricing momentum, strong balance sheet and long-term growth potential partially offset by overall inflationary outlook, surging fuel prices and political turmoil in some geographical regions.
Carnival is approaching its third quarter of operation in this fiscal year. Historically, demand for cruises has been the greatest during the third fiscal quarter, which includes the Northern Hemisphere summer months. Higher demand during the third quarter leads to increased net revenue yields. Accordingly, the company typically generates the highest earnings at this time of the year.
In addition, substantially most of Holland America Princess Alaska Tours’ revenue and net income is generated from May through September in accordance with the Alaska cruise season. Management believes that the seasonality of operation will further increase as the company expands its European brands, which tend to be more seasonal.
The largest cruise operator in the world also will likely experience a recovery in pricing, as consumer demand is once again outpacingsupply growth. Presently, the pricing environment in North America is better than last year.
Although Caribbean pricing was lower in the second quarter of 2011, pricing for the third quarter is higher than the year-ago level due to fewer capacity additions. Caribbean pricing will be strong by the fourth quarter of 2011.
The company boasts of strong financials and reported an impressive debt-to-capital ratio coupled with solid cash generation. Carnival anticipates good cash flows over the next couple of years.
However, on the flip side, inflation in fuel prices has been a cause of concern for all cruise vacation providers and shipping companies. For second quarter 2011, Carnival estimates fuel costs to increase by $140 million or 18 cents per share year over year.
One of the major competitors of Carnival, Royal Caribbean Cruises Ltd. (RCL) resorted to fuel swaps to better manage the increasing fuel costs. In addition to fuel swaps, the company has numerous West Texas Intermediate (WTI) fuel options that provide additional insurance against rising fuel prices.
Furthermore, the company reduced it outlook for net revenue yields due to route changes resulting from political disturbances in the Middle East and North Africa. As a result of political unrest in that area of the world, there was a considerable drop in demand with the consequent effect on booking volumes and pricing. Management estimates that this disruption could have a negative impact of 5 cents per share in the fiscal earnings.
Based on the above fundamentals, we expect the stock to perform in line with the market. Carnival currently retains its Zacks #3 Rank, which translates into a short-term Hold rating.
CARNIVAL CORP (CCL): Free Stock Analysis Report
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