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Carnival Corp: The Tide Is Turning for CCL Investors

It has been some time since I have been an investor in Carnival Corp (CCLCUK), but I have tracked the name for over a decade now.

Carnival Corp: The Tide Is Turning for CCL InvestorsThe investment merits of the cruise line industry have been compelling for just as long — the market remains heavily underpenetrated, cruises are fun and one of the most economical leisure activities, and with more people retiring every year across the world, they have more and more time to travel and enjoy themselves.

Unfortunately, in recent years Carnival just hasn’t been able to capitalize on these compelling trends. Earnings were almost $3 per share back in 2007, and the company spent most of its cash flow building new ships and setting them off to sea. Yet eight years later, earnings were still below that level.

However, it appears the tide may have finally shifted for the better.

Analysts project earnings of $3.40 per share this year — the first time they will exceed $3, if met. And from reading Carnival’s most recent annual report, I think the company may have hit an important inflection point in terms of cash flow production.

CCL Stock’s Company and Industry Appeal

Carnival is the largest operator in the industry. It boasts a market share of 42% and around 100 ships in operation. Last year, it served nearly 11 million guests, up from 10 million just two years earlier.

This leading position is enviable because the industry itself is appealing and has expanded steadily for decades. It also provides Carnival with pricing power, which it is increasingly relying on to maintain profitability. Back when the firm was smaller and on less solid financial footing, it would have to resort to discounts to keep its ships filled and keep needed cash flowing in to its coffers.

Compelling industry statistics abound — less than 20% of all Americans have ever taken a cruise, and the global penetration rate is even less. This speaks to a huge untapped market and decades of further growing demand.

The industry overall has grown 7.4% annually since 1980 — nearly triple the GDP growth rate. The average age of a cruise passenger is above 50, and this demographic will only increase as Baby Boomers retire and have more free time.

Yet 62% of cruisers are still working, and the typical passenger earns more than $100,000 per year, suggesting that those who work will continue to cruise and are less likely to cut a vacation during a recession.

Despite the upper-income customer base, cruising remains one of the most affordable vacations for all income levels. Weekly family cruise costs can average well below a couple thousand dollars and include cabins, food and plenty of free entertainment. Carnival also offers spending credits for its shareholders.

In the future, Caribbean travel should continue to expand in North America, but the industry also has its sights set on global expansion. Carnival just added a fourth ship in China and has two more planned in 2016. China represents just 5% of its capacity, but the firm expects the country to eventually be the largest cruise market in the world.

CLSA estimates 200 million travelers in China by 2020, many of whom will undoubtedly want to try out a cruise — and a burgeoning middle class will increasingly be able to afford a cruise vacation.

Asia overall remains another growth driver.

Cash is Finally King at Carnival

Carnival’s cash flow production is increasing and increasingly substantial. This lets it control its own destiny and represents an important safety valve for investors.

Last year, the company generated $4.6 billion in cash from operations, which is now well in excess of what it needed to build new ships and maintain existing ones. This is a welcome change from earlier years, when the company had to spend all of its cash flow and even issue debt to support its expansion plans.

$1.3 billion was left over to buy back stock and support a dividend yield of 2.8% — ahead of the market’s average yield closer to 2%.

Reasonable Growth at a Very Reasonable Price

Carnival stock is worth a close look. The firm has an industry-leading position and continued growth potential in an appealing overall industry. It plans 16 new ships through 2020.

Carnival shares are trading at 12.5 times earnings expectations for this year — well below an average of 21.7x over the past five years and a period where profit growth was shipwrecked. Given Carnival’s leadership position, this slight premium is warranted and below the market’s forward P/E of 17.

It still has to deal with archrival Norwegian Cruise Line Holdings Ltd (NCLH) and Royal Caribbean Cruises Ltd. (RCL). These players dominate the industry. Smaller operators, including Walt Disney Co’s (DIS) Disney Cruise Line, will continue as niche players that increase industry awareness.

Higher fuel costs, a recession or terrorist fears could derail Carnival’s near-term appeal, but these have proven short-term in nature since the firm’s founding in 1972.

Over the long haul, investors would be well served to consider investing in the cruise industry. Carnival is my top pick, and another perk is that shareholders are offered up to $250 in onboard credits when cruising on the company’s ships.

As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.

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