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Morningstar | Carnival's Lower 2019 Outlook Torpedoes Stock as Pricing Outlook Trends Down; Shares Undervalued

Narrow-moat Carnival reported second-quarter results that were better than expected, with earnings per share of $0.66 versus our $0.58 forecast and initial guidance of $0.56-$0.60. However, this was largely due to the timing of expenses, with as-reported net cruise costs falling 2.2%, more than our flat year-over-year expectation. More important, the company’s outlook was dismal on the yield front, with 2019 as-reported net yields set to decline 2.5%, from a 1% downtick prior. While our forecast included negative but improving yields for the full year, the updated outlook implies pricing could deteriorate in the final quarter of 2019, with both quarters in the second half of 2019 pointing to about 2.5% declines. With a modest offset for better-than-expected cost contraction for 2019, we plan to take our $66 fair value estimate down by a mid-single-digit rate but still see the shares as undervalued after a high-single-digit decline, trading at 11 times updated EPS guidance ($4.25-$4.35 versus $4.35-$4.55 prior).

While Carnival pointed to struggles in Europe (19% sourcing), it noted that cumulative advance bookings were still slightly ahead of the prior year at prices in line with the prior year, indicating that it may be reaching an inflection point on the length of its booking curve. 2020 demand was also noted as well ahead on bookings but at prices in line, which may render our 2% yield growth forecast robust depending on foreign exchange. Given that commentary from the peer set remains relatively positive, and struggles appear to be surrounding the geopolitical European landscape, we aren’t concerned about the health of the cruise industry and don’t plan any material change to our average 2% yield and 1% cost outlooks over our forecast. While Carnival may suffer disproportionately at times from its local brand exposure in certain regions, we also see the benefit of diversification bolstering its brand equity globally.