2 Key Reasons Carnival Remains Submerged

By Ryan C. Fuhrmann | September 26, 2011 AAA

Cruise line operator Carnival (NYSE:CCL) (NYSE:CUK) reported third quarter earnings ahead of analyst projections on Tuesday. However, based on management's current guidance, profits will be flat for roughly the eighth straight year. There are two primary drivers to Carnival's business, and investors may want to wait for clearer indications that they are improving before buying the stock.
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Third Quarter Recap
Sales advanced 11.7% to $5.1 billion. Passenger ticket revenue grew 12.3% to $3.9 billion and made up the vast majority of the top line at 77.2%. Onboard and other revenue, such as the sale of alcohol and entertainment, made up 18.5% of sales and increased 10.5% to $936 million. The remaining $215 million in sales consisted of tour and related revenue and grew 6.4%. Net revenue yields, an industry measure of passenger capacity, moved ahead 2.6% and ahead of the company's expectations.

Total costs grew faster than sales, increasing 16% to $3.6 billion. Higher fuel was again the primary culprit, advancing nearly 47% to $581 million. As a result, operating income improved a very modest 2.2% to $1.4 billion. Net income growth was only slightly better at 2.6% as the bottom line reached $1.3 billion. Share buybacks helped push up diluted earnings per share by 4.3% to $1.69. This came in ahead of analyst projections.

Outlook
Analysts currently project full-year sales growth just north of 9%, total sales of nearly $15.8 billion and earnings of $2.45 per share. Carnival management said to expect diluted EPS between $2.40 and $2.44 per share, or slightly below the $2.47 it reported last year.

Bottom Line
Based on the current guidance, this will be the eighth straight year where Carnival has reported earnings between $2 and $3 per share. Earnings were $2.24 back in 2004 and reached their highest level of $2.95 per share back in 2007, just before the global credit crisis was rearing its ugly head. This comes despite a steady rise in sales that, again based on current guidance, will see the top line rise nearly 63% from 2004 levels of $9.7 billion.

Steadily rising fuel costs have again been a major contributor to the flat profit trends. Overall, gross margins have steadily declined, from close to 44% back in 2004 to closer to 37% in 2010. Archrival Royal Caribbean (NYSE:RCL) has experienced a similar compression in gross margins and equally flat profits. Low fuel costs do occur, but they usually indicate a recession and fall in consumer demand, which hurts cruise ticket revenues and the related onboard services.

In many respects, the operations of cruise lines resemble that of airlines such as American (NYSE:AMR), United Continental (NYSE:UAL) and Delta (NYSE:DAL) in that fuel costs and the economic climate are major determinants of profit levels. Carnival expects a large jump in fuel costs for the full year, which, combined with the tepid economic outlook, means investors may want to wait safely on the sidelines. (For additional reading, also see Investing In Leisure Funds.)

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