Luxury cruises to beautiful destinations around the world may be an idea of heaven for some people, but probably not for shareholders in this week’s turkey, who have seen the stock sink 40% from £28 back in February 2007. The slump has mainly been due to crippling fuel costs and fears over demand for its berths as consumers cut back on expensive holidays.
Carnival (LSE: CCL), rated as OUTPERFORM by Wachovia
But the bulls argue that now is a good time to get on board the world’s largest cruise liner, which operates 88 ships across 11 brands, including Cunard and P&O with a total capacity for around 160,000 passengers. They point out that oil prices are softening and the industry offers attractive long term growth. The firm is also twice the size of its nearest rival (with a 46% market share versus Royal Caribbean’s 24%); its shares are cheap, trading on a 2008 p/e multiple of 12.5; and the bulk of its customers are older, wealthy couples who will not be affected by the credit-quake.
Yet while all this may be true, I just don’t believe Carnival will be able to escape the problems of the wider economy. Firstly, one must remember that the sector is a lagging indicator of cyclical activity because most travelers book their holidays six to 12 months in advance. So 2008 may have been rough, but I suspect the seas will be far stormier in 2009, as consumers choose cheaper options.
What’s more, this process is just starting. Last month CEO Micky Arison acknowledged for the first time that advance bookings were “running behind” 2007 levels. Worse still, the impact of the sluggish demand could be magnified by Carnival’s plans to launch another 18 ships (incurring a cash-outflow of around $9bn) over the next four years – equating to a capacity expansion of more than 20%. To me this strategy is flawed, as it will lead to over capacity, declining utilisation rates and heavy discounting.
And here’s the really scary thing. If prices and occupancy levels fall, then with its high fixed-cost base, these lost sales will largely drop straight to the bottom line. For example, if net revenues per cabin fell by a similar amount (ie 9%) as during the 2001 to 2003 slump, I estimate earnings per share would fall 40% from $2.80 to around $1.60 – perhaps also triggering a cut in the dividend. OK, so what are the shares worth? Well we have to strip out the distortive effects of the $8.7bn debt pile, the depreciation charge relating to the ships, and the ups and downs of the industry. So I would rate the stock on a through-cycle EBITDA multiple of eight, generating an associated intrinsic value of about £13 a share, or 20% below today.
There are also other risks such as foreign-exchange fluctuations, bad publicity, terrorism and accidents. Together with its historical dependence on cash-strapped American consumers (70% of tickets sold are for US departures), then this is one stock to steer away from.
Recommendation: SELL at £16.99
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.