With its shares down 49% over the past 12 months, Carnival(CCL 2.85%) will probably catch the attention of deal-hungry investors looking to bet onthe next bull market. But it pays to look before you leap. While Carnival's business outlook is improving rapidly, the embattled cruise operator isn't in calm waters yet.
The operational recovery has started
While the stock price is still down substantially from previous highs, Carnival has enjoyed a 22% rally year to date because of improving operational metrics. The company exceeded guidance in the first quarter, with revenue almost tripling to $4.4 billion from a year ago.
Granted, Carnival benefited from easy comps against the prior-year period, when it was still dealing with pandemic-related restrictions. But it looks like the company is finally getting over the crisis.
In late 2022, management eliminated some of the last remaining requirements related to COVID-19 testing and vaccinations. And now, bookings (customer pre-orders for cruises) have soared to record levels while revenue stands at 95% of the corresponding pre-crisis quarter.
Carnival's rebound has earned it a rash of analysts' upgrades, with Wells Fargo shifting from an underweight to an equal-weight rating on the view that the company's risk-reward profile has balanced out. But investors shouldn't necessarily take this optimism at face value.
The risks remain substantial
Carnival's biggest problem is its high valuation, even though shares look affordable on the surface. A market capitalization of $12.7 billion means it trades for just over four times its pre-COVID annual net income ($3 billion), which is substantially less than the S&P 500's average price-to-earnings (P/E) multiple of 22. But when you buy a stock, you are exposed to its debt in addition to its equity -- a fact better illustrated by a metric called enterprise value (EV), which adds the company's net debt to its market capitalization.
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Right now, Carnival has an EV of $42 billion, which is less than a 10% discount to its pre-COVID EV of $46 billion. This doesn't seem adequate considering how much the company has deteriorated over the last three years and the possibility that it will not soon return to prior levels of profitability.
Unlike before, Carnival now faces over $1.6 billion in annual interest expense, which will make pre-COVID net income extremely difficult to replicate. And debt paydown will be a continuous drain on cash flow, making it harder for the company to afford capital expenditures needed to grow and maintain its fleet while having cash left over for investors.
Is Carnival a buy?
Despite its improving fundamentals and analyst upgrades, Carnival stock is not a buy. The company is unlikely to reach pre-pandemic levels of profitability anytime soon. And the shares still look overvalued considering its massive debt levels. Investors should look for better ways to bet on the next bull market.
Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool recommends Carnival Corp. The Motley Fool has a disclosure policy.
