If you read my latest article, which summarizes the first quarter of the year, you will see that I lack some exposure to the consumer staples and consumer discretionary sectors. In total, I would like to allocate 2% more of my portfolio to these sectors. I hope to share with my analysis for some companies in these sectors. I will try to analyze several sub-sectors, to have a broader range of possibilities.
In the consumer discretionary sector, I am looking forward to initiating a position with Starbucks (SBUX). However, I still find it overvalued at the moment due to the combination of high P/E and slower EPS growth. After a year and a half, it is time for me to look again at cruise liners. Last time I analyzed the sub-sector, it was very attractive, and the total returns were much higher than the broad market.
In this article, I intend to analyze Carnival Corporation (CCL), the largest cruise line company in the world. I will analyze it using my graph below. I will investigate the fundamentals, valuation, risks and opportunities. I will then use the information in order to conclude whether the company is an interesting investment for my dividend growth portfolio.
Carnival Corporation operates as a leisure travel and cruise company. It offers cruises under the Carnival Cruise Line, Holland America Line, Princess Cruises, and Seabourn brands in North America, and AIDA, Costa, P&O Cruises (Australia), Cunard, and P&O Cruises (NASDAQ:UK) brands in Europe, Australia, and Asia. The company operates approximately 100 cruise ships. It also owns Holland America Princess Alaska Tours, a tour company in Alaska, and the Canadian Yukon, which owns and operates hotels, lodges, glass-domed railcars, and motor coaches.
Over the past five years Carnival showed healthy growth in its top line. The revenues grew by over 17% and are forecasted to grow even more in the medium term. I will discuss the reasons for the revenue growth later in the article. A cyclical business such as Carnival may suffer from erratic revenue growth in the short term, and therefore, we should look at five years period. A long-term trend of revenue growth is crucial for a company if it wishes to grow its bottom line and the dividends paid to shareholders.
The next graph is very impressive. It shows the growth of the EPS and the FCF. Carnival not only showed amazing net income growth, but it also showed fantastic cash generation. The FCF is crucial because this is the cash that will be paid in the form of dividends to the shareholders. The even better news is that trend is forecasted to continue in the medium term as the company and the analysts believe that the company will continue to grow its bottom line by over 10% annually. Again, due to the cyclical nature of the business this growth rate forecast should be taken with a grain of salt.
This is a little bit confusing. Over the past decade Carnival had an erratic dividend policy. It was cut in 2008, then froze in 2011 for three years only to be raised again since 2014. Over the past four years, the dividend has doubled, and the next quarterly payment announced last week will be $0.5 per share. Hopefully, the company will adopt a growing dividend policy. At the moment it has everything it needs in order to it. The payout ratio is sustainable at less than 50%, and the dividend yield is attractive at more than 3% after the latest raise. I would like the management to offer annual conservative raises in order to rebuild the confidence of its investors.
Another form of returning capital to shareholders is the share buyback program. Last week, the company announced that it will use $1 billion to buy back its own shares. Buying back shares is a good strategy when the company is cheap. In the next section I will look at the valuation. The graph below shows us that the buybacks have already started in 2016. The number of shares outstanding decreased by 7.5%, and the current plan will reduce it by 2.2% more.
The fundamentals are strong, and it’s time to look at the valuation. The share prices of the whole sector decreased over the past several months. This pullback offers investors a much more attractive valuation. The trailing P/E is just 17.2 which in my opinion is attractive for a company growing its EPS at double digits pace. Moreover, a look at the forward P/E shows us that Carnival is not only attractively valued, it’s also the best valuation we have seen in the past twelve months.
You can see in the Fast Graphs chart below that Carnival is attractively valued. It trades for a P/E ratio that is lower than its historical ratio. Moreover, the company is getting close to the same valuation it offered in the summer of 2016. The growth rate hasn’t slowed down, so we have an opportunity to purchase more shares for a valuation that is almost just as attractive as it was.
Carnival looks like an attractively valued company with strong top and bottom line growth. The recent pullback made it attractive, but I am still concerned about the management’s commitment to return cash to the shareholders. Moreover, I will now look at the risks and growth opportunities that will dictate the growth in the medium and long term.
The first growth opportunity is the growth in discretionary spending. The tax reduction together with the wage growth will allow people to spend more money. Therefore, discretionary spending will grow. People will allocate more funds towards vacations and leisure. Carnival as a leading provider of leisure services is poised to enjoy the growth in spending by the American people.
The company is also diversified globally. It dispatches its cruise ships from Europe, North America, South America and Asia. It allows it to get costumers from around the world. It diversifies the revenue stream, so it doesn’t rely solely on the North American clients. Moreover, the company offers cruises with several brands. Each brand is somewhat unique. One is more suitable for families, the other is more luxurious and it goes on and on. It has the right product for every costumer.
Another way of getting more from your position is using the shareholders benefits. It is only useful for people who use the products of Carnival. It requires you to have 100 shares or more. It gives you onboard credit of up to $250 per cruise. If an investor holds 100 shares, he will get $200 in dividends, and he will also get additional credit if he cruises with Carnival. If you do, it may be a very lucrative deal for you.
In addition to the tax cuts that will help boost discretionary spending, the demographics will also help. The American population is aging, and the baby boomers are retiring. As they retire, they will seek more leisure activities. The boomers are retiring with plenty of money and their retirement accounts. In addition, on the other side of the world a whole middle class is forming in countries like China. These two trends will support the growth of Carnival in the long term.
The business is very cyclical. It grows very fast when the economy is booming. However, in case of a recession, discretionary spending is cut first by costumers. Therefore, in 2008 the earnings decreased substantially. Investors should take this into consideration, and the company should maintain its dividend payout sustainable even in a recession. This is probably the most important risk for any cyclical company. Management must be ready for it and have a business plan.
The business is not only cyclical, but it is also a capital-intensive business. The cruise ships are very expensive to build, maintain and renovate. Companies in the sector must be very conservative. They must reward shareholders, invest billions of dollars back to the business, and get ready for a rainy day, which will come. Therefore, the management team should be an experienced one.
The company has a poor dividend history, as it has already cut its distribution in the past decade. From my perspective, raising the dividend to a point where the company cannot sustain when the cycle turns south is a failure by the management. I have no proof that the management has learned from this mistake and that it can allocate its capital better in the future.
The last risk is the competition. While the business is capital intensive, the demand for cruise ships is also high. Existing companies and new companies will try to get some of Carnival’s market share. Competition of course may come not only from the well known American and European brands, but also from Chinese competition who look to fulfill the demand for leisure of the Chinese middle class.
Carnival is a good company with strong fundamentals and attractive valuation. It has plenty of growth prospects that will drive the top and bottom line forward in the future. However, it also has some inherent risks. Overall, I think that this is a leading company with relatively wide moat that can offer impressive long-term returns to its shareholders.
I am still very concerned with the dividend record. It’s not only the dividend as a payment and reward to shareholders. I see the dividend as an example to the management’s ability to allocate the capital, prepare for the future, and get ready to deal with the risks ahead. I have a small position in the company, and I will sell it if the company cuts the payment. At the moment the trend seems positive.
I think that investors should consider a small position in the company. They can add at dips, and let the management prove its ability to allocate funds wisely. This is my strategy, as I initiated a position 18 months ago, and I consider adding some more to my position in Carnival or one of its peers.
Disclosure: I am/we are long RCL, CCL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.