Sell Carnival? It’s Not So Clear-Cut

The Concordia tragedy won't drive Carnival into bankruptcy, but other problems lurk

   
Sell Carnival? It’s Not So Clear-Cut

Without in any way overlooking the human loss surrounding the tragedy of the Costa Concordia cruise ship, many investors in the ship’s owner Carnival (NYSE:CCL) are wondering if their investment is now at risk. Many sold at the first opportunity in Tuesday trading, knocking the stock down 13.65%. It’s important to understand that Carnival is insured for incidents like this, so no matter how high the liability claims may rise, the disaster won’t drive Carnival into bankruptcy.

It will have some economic impact, however. For starters, insurance comes with deductibles, and some sources place Carnival on the hook for $40 million. That’s a minor impact on a company with $2 billion in trailing 12-month earnings.

Beyond this, is the question of how much revenue will be lost from canceled bookings and from travelers who avoid Carnival in the near and long term as a result of the disaster. That number is difficult to project, but negative events like these aren’t unprecedented.

Recall what seemed like an endless outbreak of viral illnesses aboard cruise ships a few years ago. It was big news at the time, but it eventually faded away, and business returned to normal. Similarly, this terribly unfortunate event will also fade into corporate history (but not, of course, for those who lost loved ones).

So, in short, I don’t think this tragedy will have a material long-term effect on Carnival. I actually have greater concerns, and they involve the company’s financials. It takes a lot of capital to build those mega-ships, and that means cruise lines carry a lot of debt. Carnival has $7.7 billion of it, offset by $430 million in cash. So far, the company has been able to meet its debt service, thanks to robust revenues.

The problem is that Carnival hasn’t generated significant free cash flow for many years, and eventually that debt has to get paid down. A short-term hit to revenue as a result of this accident won’t help matters.

Now, Carnival is hardly going bankrupt. It’s doing just fine, and is seeing a nice upswing post-financial crisis, with 15% earnings growth projected for 2012 (pre-Concordia). But another problem with the stock is its volatility, because the cruise business depends on the economy. If you look at the chart, you’ll see that Carnival is probably a better trading stock than an investing stock, and the time to get in is if it hits $20.

The same goes for competitor Royal Caribbean Cruises (NYSE:RCL). It also has a lot of debt, but its free cash flow has been negative for several years and is arguably in even worse financial shape. You’ll note its chart is similar to Carnival’s. In this case, buy below $10.

For those who still see Carnival stock as an investment vehicle, my guess is that this crisis will pass, and it’s not a cause to sell out.

Lawrence Meyers does not own shares of any company mentioned and has never taken a cruise.


Article printed from InvestorPlace Media, http://investorplace.com/2012/01/sell-carnival-its-not-so-clear-cut/.

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