Carnival Corp (CCL) showed in its latest earnings released today it is making large amounts of free cash flow. That is enough to cover its debt payments and could lead to dividends sometime in the future. As a result, CCL stock looks deeply undervalued. It could even lead to a situation where the company could begin paying dividends in the future.
I estimate that CCL stock could be worth well over double from here, based on its huge adj. FCF margins. That means the stock could be worth $43.42 per share, +145% from today.
The stock is up today at $17.68 per share. But this is still well below its previous highs in 2020 before the COVID pandemic when it was well over $51 per share. Now the company is starting to produce equivalent free cash flow (FCF) that could propel it significantly higher.
As a result, CCL stock looks like it could be worth 140% more or
Strong Free Cash Flow (FCF) Results
Carnival reported that its revenue rose 17.7% Y/Y from $4.911 billion last Q3 to $5.781 billion for the May 31, 2024 quarter. In addition, the company's operating cash flow rose from $1.136 billion last year to $2.04 billion, up 79.6%.
More importantly, after capex and proceeds from export credits, its adjusted free cash flow (FCF) rose from $625 million last year to $1.3 billion this past quarter. That represents a huge 108% gain in FCF Y/Y.
But it's also important since it represents a very high percentage of sales. The $1.3 billion in adjusted FCF is 22.5% of the $5.781 billion in sales for the quarter. That high adjusted FCF margin augurs well for the company's ongoing FCF-generating ability.
Free Cash Flow Projections
Carnival's CFO, David Bernstein, underlined this in his statement on FCF:
"Looking forward, we expect substantial free cash flow driven by our ongoing operational execution and the lowest newbuild order book in decades to deliver continued improvements in our leverage metrics and balance sheet."
In other words, expect the company to continue to make these high FCF margins. That implies that CCL stock could be undervalued. Let's look into how that could work out.
For one, we can project its adj. FCF over the next 12 months (NTM). For example, analysts now project revenue will hit $24.55 billion for the year ending Nov. 2024. And for next year, the estimate is 5.5% higher at $25.91 billion.
That implies its NTM run rate revenue will be $25.23 billion over the next 12 months. Therefore, if Carnival keeps making 22.5% of its revenue in adjusted FCF, it could end up making $5.677 billion in adj. FCF over the next 12 months.
Dividends Possible from FCF
That is more than enough to cover its upcoming principal debt payments. For example, the company said that as of May 31, 2024, its outstanding debt maturities for the remainder of the year, 2025, and 2026 were $1.2 billion, $1.7 billion, and $2.8 billion.
In other words, there will be more than enough FCF to begin making dividend payments like it used to in 2020. So far, the company has not said it will do so. But, if it announces this at the end of this fiscal year, expect to see CCL stock skyrocket.
Price Targets for CCL Stock
One way to value CCL stock is to assume that it pays out 100% of the FCF as a dividend (even though it would need to use some of it to cover debt payments). In that case, the market would likely have at least a 10% dividend yield.
So, for example, if we divide the project adj. FCF $5.677 billion by 10% we get a project market cap of $56.77 billion (i.e., $5.677/0.10 = $56.77 billion). This is also the same as multiplying the FCF by 10x.
This result is 145% higher than its present $23.167 billion market cap. In other words, CCL stock is worth 2.45x the present price of $17.68, or $43.32 per share.
Analysts tend to agree that CCL stock is still undervalued. For example, the average of 18 analysts surveyed by Yahoo! Finance shows they have an average price target of $20.77. Moreover, AnaChart, a new sell-side stock analyst tracking service, shows that the average price target of 19 analysts is $22.04 per share.
The bottom line is that CCL stock looks deeply undervalued here given its recent results. In fact, I expect analysts will likely raise their price targets with these latest results.
Shorting OTM Puts
One attractive way to play this is to sell short out-of-the-money put options in nearby expiry periods. For example, look at the July 19 expiration period, 25 days from now. It shows that the $17.00 strike price put option contract, which is 3.57% below today's price, has a bid premium of 38 cents per put contract.
That means that a short seller of this put contract can make an immediate yield of 2.23% (i.e., $0.38/$17.00). That is a very good yield for an OTM put play with just over 3 weeks to expiration.
Here is what it means. The investor first secures $1,700 with their brokerage firm. Then they can enter an order to “Sell to Open” 1 put contract at $17.00 for expiry on July 19. The account will immediately receive $38.00. And shorting 10 contracts requires $17,000 in cash and/or margin. But the account will then receive $380 in immediate income.
Either way, that works to an immediate income of 2.235% (i.e., $38/$1,700 or $380/$17,000). Moreover, if the stock price never falls to $17.00 before July 19, the secured cash will not be used to buy 100 shares at $17.00 per share.
That means that the investor not only keeps the income but can later repeat the same play. So, for example, over the next quarter, if repeated, the investor could make $152 if done 4 times, on $1700 invested. That works to a quarterly expected return (ER) of 8.94%. This is a very good return.
Moreover, even if the stock hits $17.00, the investor has confidence that the shares bought at that price are worth substantially more. In addition, the breakeven price is lower given the income received.
The bottom line is that CCL stock looks deeply undervalued here. It could be worth well over double the existing price if Carnival keeps making such huge FCF margins. That is one reason why it makes sense for existing shareholders in CCL stock to sell short OTM puts in nearby expiry periods. That way they keep all the upside in the stock along with short put income.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
