Carnival Stock’s Expected Return Is Low, As the CDC Doesn’t Want to Yield

Stocks to sell

Carnival Corp’s (NYSE:CCL) hopes lie with the Centers for Disease Control and Prevention (CDC), which so far doesn’t want to give way. It doesn’t want to lose control of its hold on the U.S. cruise industry. As a result, CCL stock could be subject to a volatile ride this year, especially if the CDC stubbornly doesn’t yield.

Carnival (CCL) cruise ship on water in front of beach with chairs

In fact, over 30 countries have already granted permission for cruising, according to a statement by the CEO of its rival, Royal Caribbean (NYSE:RCL). The point is, the CDC has been reluctant to grant any kind of real cruising opportunity. They still have not even set a date to allow full-time cruises to operate out of the U.S. For example, here is the latest statement from early April from the CDC:

“CDC is committed to working with the cruise industry and seaport partners to resume cruising when it is safe to do so, following the phased approach outlined in October’s conditional sail order.”

That means the CDC is still dithering about an exact date for when the cruise industry can start. This is the kind of uncertainty that investors do not like to see in a stock. So far this year, CCL stock is up about 18.2%, as of the time of publication. However, it is still down about 16.5% from its recent highs.

Earnings and Sales Turnaround

Analysts still expect to see Carnival make $4.19 billion in sales this year, according to Seeking Alpha. That is looking increasingly difficult, especially if the company is not allowed to begin operations for the crucial summer and fall season. Spring is pretty much written off for now.

At yesterday’s closing price of about $26.89, CCL stock traded at 7.3 times sales, given Carnival’s market capitalization of $29.94 billion.

However, assuming cruises don’t begin this fall, that could hit sales pretty significantly. For example, the August quarter had the highest sales and accounted for 31.5% of total sales for the year ending November 2019. Assuming Carnival loses sales this year, that would reduce sales down to 68.53% of $4.19 billion, or $2.87 billion. That increases the price-to-sales (P/S) ratio this year to 10.4 times sales. That is way too high.

A more appropriate valuation would be half of that amount, or three to five times sales, including the lower sales estimate. This would put CCL stock on a market value of $14.35 billion. That is about 50% of today’s price today, or $12.91 per share.

What to Do With CCL Stock

The truth is, hope springs eternal. In other words, even though CCL stock is not worth more than 50% of today’s current price, everyone hopes that things will get back on track at some point.

Shareholders in CCL stock are reluctant to get out of their position just because the CDC is holding things up. I guess the thinking is that at some point the CDC has to give in to the industry’s request to get cruising and sales going again.

This leads me to my favorite way to assess a stock’s value. Using probability. That’s right. Taking an educated guess about where the stock is headed and assigning probabilities. This results in an expected return (ER) for the stock. This is a simple, practical way to be realistic about making an investment and/or keeping track of one you are in.

Using Probability to Assess Expected Return

For example, as the CDC is under pressure to let cruising begin, let’s say there is a good 50% probability they give in. But there is a 30% chance that the CDC could dig its heels in and say, “no more cruising during 2021.” Lastly, let’s assume that there is a 20% likelihood they won’t yield until the fall of 2021. The sum of these three possibilities is 100%.

These three scenarios have consequences, or expected returns. For example, the ER for the first scenario is probably about a 30% gain in the stock, at most. After all, it has already risen a great deal in the past year, up 104%. Therefore, the expected return is 50% (the probability) times 30%, or 15%.

The second scenario could lead to a 50% cut in CCL stock, as investors would be disappointed. The ER would be -15% (i.e., 30% times -50%). So far, the first and second scenarios have a zero expected return (i.e., 15% plus -15%).

The third scenario, where the CDC drags its heels until the fall, could lead to a rise in the stock but not before first falling. The net result might be a 10% gain (i.e., a 20% fall and then a 30% rise). This means that the ER is 2% (i.e., 20% probability times the 10% gain).

So, in total, the expected return is just 2% (i.e., 15% plus -15% plus 2%). That is just not worth much for most investors. Stay away from CCL stock.

On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.