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With Fear in the Markets, Carnival Looks Like an Attractive Investment

If investors have to choose only one piece of advice given by Warren Buffett (Trades, Portfolio), the following might prove to be the most lucrative one: "Be fearful when others are greedy and be greedy when others are fearful."


There have been many instances throughout history in which investors took the back seat driven by fear of failure, only to miss the best investment opportunities that were presented to them. Not investing in financial stocks during the aftermath of the financial crisis is a classic example of this. As many are aware, Buffett did not miss this.

Fast forward to today, markets are overwhelmed by fear of the new coronavirus. Leisure stocks are one of the most beaten-down sectors during the breakout of this virus. Carnival Corp. (NYSE:CCL) has seen its stock price plummet in the last week, and investors continue to remain on the sidelines.

Source: GuruFocus

Following Joel Greenblatt (Trades, Portfolio) and investing in Carnival shares could lead to significant capital appreciation returns in the next couple of years. The dividend yield of 4.5% serves as an added source of income.

The business

Carnival is the world's largest leisure company with revenue exceeding $20 billion in 2019. At the end of the fiscal fourth quarter in November, the company owned 104 ships and had 21 new ships scheduled to be delivered by 2025. According to company filings, its fleet visits more than 700 ports around the world, making Carnival a truly global company.

According to a report by The Motley Fool, at the end of 2018, the company accounted for more than 50% of the market share by passengers. This market-leading position continues to provide Carnival with competitive advantages and to emerge as the go-to service provider in its space.

Outlook

The fortunes of Carnival are closely tied to the growth in cruise passengers worldwide. Cruise Market Watch, which is one of the leading agencies monitoring the industry, projects more than 27.6 million passengers to be carried in 2020, which is a significant improvement from the numbers reported in 2017.

Source: Cruise Market Watch

There are several reasons behind this expected growth in the industry, including the increasing disposable income in the Asia-Pacific region. The World Bank projects Asian countries such as India, China, Thailand and Vietnam to grow at much higher rates than the developed world in the next decade, resulting in an exponential growth of personal disposable income. This paves the way for leisure companies to gain traction, including Carnival.

Back in 2016, the company signed an agreement with Italian shipbuilder Fincantieri to build four new cruise ships with the aim of deploying two of them to its Asia operations. At the end of 2019, however, the Caribbean region accounted for the highest number of ships deployed.

Source: Cruising.org

Much of future growth could come from Asia. The company has identified this massive opportunity and has already invested to benefit from the projected increase in leisure travels in the fastest-growing region of the world.

The increasing trend of working-from-home or freelancing will be a driver of the growth of this industry as well. As opposed to a regular job that requires professionals to stay indoors, this new trend enables working while traveling, which has prompted many to consider such options. According to the results of a survey conducted by Upwork and Freelancers Union, there were 57 million freelancers in the United States at the end of the third quarter of 2019. The findings further reveal that 30% of professionals have made the decision to go freelance because of their plans to travel the world while working. This is good news for Carnival as the company provides best-in-class solutions to capture this market share.

Finally, there's some hope for cost reductions on an industrywide scale as well. Carnival Corporation and some of the other leading cruise ship operators are turning to liquefied natural gases (LNG) instead of fossil fuels to run their ships. For decades, the industry has been vulnerable to spikes in crude oil prices, as profitability has a negative correlation with an increase in fuel prices. The company, as confirmed in earnings calls in 2019, is focused on shifting to alternative energy sources in the next decade to mitigate this risk.

Dividends add to the total return

Not only is Carnival significantly undervalued in the market, but shares also yield a very attractive 4.6% dividend at the market price of around $43.53 on Monday. Over the last ten years, the company has consistently hiked dividends per share in line with the company policy to distribute income to shareholders.

Source: GuruFocus

The payout ratio, however, has not deteriorated and has stayed below 0.5 throughout this period. This is an indication of the company covering its dividends with increasing earnings per share, which is a good sign for investors. According to data from GuruFocus, Carnival has paid out more than what it earned in free cash flow in 2019. However, this is the first time it has happened since 2013, which highlights the commitment by the management to keep distributions at a manageable level.

Valuation

According to data from Morningstar, Carnival shares have traded at an average price-earnings ratio of 17.52 in the last five years, and the pessimism surrounding the spread of the new coronavirus has pushed them to an earnings multiple of just 10. The long-term outlook for the company is little changed because of the breakout of the epidemic, which leads to the conclusion that the drastic drop in share prices is unwarranted. Royal Caribbean Cruises Ltd (NYSE:RCL), which is the closest rival of Carnival on a global scale, is trading at much higher valuation multiples, which confirms the mispricing of Carnival shares.

Source: GuruFocus

A discounted cash flow valuation model resulted in an intrinsic value estimate of $57.95 for shares, which indicates an upside of 33% from the market price of around $43.53 on Monday. Wall Street analysts agree that shares are undervalued and have a median target price of $51.91, according to data compiled by TipRanks.

Takeaway

When there's fear in markets, attractive opportunities emerge for investors. However, there's a tendency to remain on the sidelines until things supposedly look bright, which is often too late. The markets are punishing travel stocks around the world, and Carnival Corporation shares seem mispriced. When the coronavirus fears subside the same way it happened with other epidemics, Carnival shares will likely recover quickly as the company is operating in an industry that is expected to benefit immensely from several macroeconomic developments, including the growth in popularity of freelancing and continued economic growth in emerging regions such as the Asia-Pacific.

According to data from GuruFocus, Joel Greenblatt (Trades, Portfolio) of Gotham Asset Management purchased Carnival shares in the third quarter of 2019, when shares were trading at an average price above the current market price of around $43.

Source: GuruFocus

Investors can now purchase the same shares at a discount to what he did, and the expected revenue and earnings growth will act as catalysts for shares to converge with the five-year average earnings multiples.

Disclosure: I do not own any shares mentioned in this article.

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This article first appeared on GuruFocus.