The travel sector is generally considered one of the most sensitive to macroeconomic conditions.
After all, travel, for both business and pleasure, is typically discretionary spending, meaning it's not a necessity. Therefore, when consumers and businesses are looking for expenses to cut, travel is often one of the first to go.
That thinking has pressured travel stocks in the recent stock market pullback. However, it's also created opportunities, and one of those is in Carnival (CCL -4.54%), the world's largest cruise line.
Carnival is now down 70% from its all-time high in 2018 before the pandemic, but it's also off 25% from its peak earlier this year, a reflection of those recessionary concerns.
While Carnival and the rest of the cruise industry were left for dead during the pandemic, the company and its peers bounced back successfully, benefiting from "revenge travel" and record-setting demand, even years after pandemic-era sailing restrictions ended.
Let's take a look at why Carnival is a compelling stock to buy right now.
Image source: Getty Images.
Demand is strong
Unlike some travel stocks such as Airbnb and several lines that have cut guidance and complained of slowing growth, Carnival continues to see smooth sailing ahead, and the company just reported strong results in its fiscal first quarter.
Revenue rose 7.5% in the quarter to $5.81 billion, a Q1 record. But more importantly, the company delivered strong margin expansion as generally accepted accounting principles (GAAP) operating income nearly doubled to $543 million, also a record for Q1.
Management also noted that net yields, or pricing, topped its guidance due to strong close-in demand and better-than-expected onboard revenue.
Despite the macroeconomic headwinds, the company raised its guidance for the year, calling for adjusted net income growth of 30% to $2.5 billion and cruise-level margins, excluding fuel, to improve 90 basis points.
Based on its forecast of adjusted earnings per share of $1.83, the stock now trades at a forward price-to-earnings (P/E) ratio of 12.
Carnival is more recession-resistant than you think
On the earnings call, CEO Josh Weinstein pushed back on the notion that the company was at risk from weakening consumer sentiment, citing the strong Q1 results and raised guidance.
He also noted that the profile of the business is different from airlines and hotels because Carnival doesn't have any exposure to business travel. Its demand is entirely driven by leisure and vacation travel, and with the unemployment rate still low in much of the developed world, Weinstein argued that economic conditions favor the business.
Weinstein also said that cruise vacations offer great value compared to land-based vacations, meaning they can serve as a good option for a family or anyone looking for a vacation on a budget.
The balance sheet is improving
On an operating basis, Carnival has made a full recovery from the pandemic, and its operating margins are strong.
However, the company took on a lot of debt to survive the pandemic, and it's gradually paying it down and reducing its interest expense, driving overall profitability.
In Q1, the company refinanced $5.5 billion of debt, cutting interest expense by $145 million annually.
In 2024, the company paid $1.76 billion in interest expense, about half of its operating income, showing that lowering its interest expense could give a significant boost to profitability, essentially providing a tailwind for earnings growth.
Why it's a buy
Carnival combines the strength of an industry leader, steady growth even as other travel stocks are struggling, tailwinds from its debt reductions and refinancing, and an attractive valuation.
Over the longer term, there's potential for the company to reinstate dividend, and it should continue to benefit from the shift in consumer spending, especially among younger generations, for spending discretionary income on experiences rather than products.
Carnival's recent pullback doesn't reflect its strong Q1 results. Investors would be wise to take advantage of the discount while it's still around.
