Stockpickers: Tide turning over attitudes to cruise group Carnival’s debts

Rough seas are a risk for those who like their holidays aboard luxury cruise ships, but investors in cruise operators can’t expect plain sailing either, writes Rosie Carr.

What’s troubling the sector these days is not so much the backlash against overtourism, or the challenge of decarbonisation, as high levels of borrowings. Debt at Carnival, owner of nine cruise brands, swelled by a factor of three as it battled to stay afloat during the pandemic, and as new vessels had to be bought. 

Being highly leveraged is not normally a problem. Debt unlocks future growth and is tax deductible. No one bats an eyelid when the cost of servicing loans is manageable, and unlikely to rise. Nevertheless, investors need to watch for red flags such as when debt rises quickly, profits are nosediving, or loans are due for repayment and there is no cash pile or willing creditors to tap. 

Oil services group Petrofac finds itself in this predicament. It has a batch of loans maturing this year while its losses are mounting. A debt to equity conversion may be on the cards, carrying dilution risks for existing shareholders. 

But the warning flags around Carnival’s $29bn debt are being lowered. Although its debt is still rated below investment grade and some chunky principal payments are looming, investors’ fears have been allayed by its recent record profitability and the refinancing of its pricier debt with cheaper loan notes. With bookings and earnings continuing to rise strongly, that’s casting the company’s debt-to-ebitda ratio in a whole new light. 

BUY: Carnival (CCL)

Progress is being made towards returning its bonds to investment-grade status, writes Christopher Akers.

The vigorous rebound in cruise demand shows few signs of letting up after global volumes surpassed the pre-pandemic baseline last year. Carnival beat its guidance in its half-year results and raised its forecasts on the back of another record performance, and the market leader is starting to make inroads into tackling its debt problem. 

Adjusted cash profits rose 75 per cent to a record $1.19bn (£945mn) in the second quarter, helped by higher ticket prices and onboard spending. Management now expects an annual figure of around $5.83bn, up 40 per cent on 2023 and $200mn ahead of March guidance. 

A revenue surge of a fifth in the half was underpinned by strong demand, as year-on-year occupancy rose from 95 per cent to 103 per cent and passenger numbers improved from 5.7mn to 6.3mn. Passenger ticket revenue jumped 23 per cent to $7.37bn, while onboard and other revenue was up 15 per cent to $3.82bn.

Looking ahead, bookings sit at a record level for 2025 and the cumulative advanced booked position for next year is ahead of 2024 in both price and occupancy terms. Customer deposits reached a peak level of $8.3bn at the half-year mark, around $1.1bn ahead of last year. 

New annual guidance is for year-on-year net yield growth of around 10.25 per cent, an improvement of 75 basis points from the forecast in March. Yields should be assisted going forwards by the capacity outlook.

The main risk with Carnival from an investment standpoint is its huge debt pile. Leverage was around 6.4 times at the last year-end. Carnival had a liquidity position of $4.6bn at the end of the half, with outstanding debt maturities of $5.7bn out to 2026. 

There are signs of balance sheet improvement as management targets a return to investment-grade status by 2026. Debt maturities are starting to look more reasonable and debt is being refinanced at cheaper levels. Debt reduction is being aided by improved cash generation, with $2bn of cash generated from operations in the second quarter.

Analysts at Peel Hunt “expect a steady process of refinancing to continue; to reduce the cost further, and to increase the maturity of the group’s debt”. 

The shares trade at 12 times forward consensus earnings, an undemanding rating given the outlook. This, along with an improving picture for the balance sheet, has changed our view.

BUY: XPS Pensions (XPS)

The sale of the National Pension Trust boosted reported profits, but underlying growth was still impressive, writes Mark Robinson.

XPS Pensions’ full-year figures were well received by the market, unsurprising given that the pensions consulting and administration group delivered double-digit sales increases across all its business segments. The pensions administration business was probably the standout performer with adjusted revenues up by 25 per cent to £71.9mn, although the pensions actuarial and consulting unit drove its top line by a similar margin. Reported profits benefited from the sale of the National Pension Trust for an initial cash consideration of £35mn, although they were still up by 38 per cent on an adjusted basis to £44.5mn.

Operational gearing supported profitability, with the adjusted cash margin up by 240 basis points to 27.9 per cent. XPS put the seventh consecutive year of revenue growth since its admission down to “the non-cyclical, predictable and resilient nature of the business”, together with “the benefits of investments made in services in prior years”. That’s not an unreasonable boast, but as we have cautioned previously, “margin growth has been a sticking point” in spite of the evident structural growth drivers. Tellingly, the improvement in marginal profitability through full-year 2024 was achieved against an inflationary backdrop, but operating expenses fell as a proportion of group revenues.

Management maintains that opportunities are opening up due to the growing overlap between the pensions and insurance industries, a point borne out by changes to the way in which bulk annuities are increasingly handled. The strong trading momentum has continued into the current financial year and the group’s elevation to the FTSE 250 index should translate into enhanced mandated support. The forward rating of 15 times consensus earnings leaves room for share price gains given growth prospects.

HOLD: Halfords (HFD)

Consumers are still reluctant to spend on bikes, writes Jennifer Johnson.

Motoring and cycling group Halfords is still grappling with headwinds outside its control. At least that’s how management explained the group’s falling profits and diminishing margins across the year to the end of March. 

Amid the ongoing cost of living squeeze, consumers appear to have cut back on big-ticket discretionary items, such as new bikes. Volumes in Halfords’ cycling business fell 30 per cent in full-year 2024, while consumer tyre volumes were down 14 per cent. The company has predicted that it will shift even fewer units in the current financial year, as drivers continue to delay car maintenance. 

Persistent inflation compounded these challenges by increasing the company’s cost base by around £37mn. It’s therefore unsurprising that the gross margin was down 50 basis points to 48.2 per cent. But it’s not all bad news: revenue from autocentres was up nearly 17 per cent, largely thanks to the growth of its commercial fleet services unit.

Pricing initiatives helped Halfords to offset the dilutive impact of acquiring Lodge, a major tyre provider to commercial fleets, in October 2022. Autocentres’ gross margin of just over 50 per cent was some 180 basis points higher than in FY2023. 

Halfords has also partnered with specialist distributor Bond International to restructure its commercial tyre supply chain – a move that will save it around £5mn a year. The balance sheet also appears to be in reasonable shape, with leverage of 1.7 coming in just under management’s target of 1.8. 

Nothing in the results seemed to shock investors, with the shares rising just over 2 per cent on the day of their release. But whether there will be any near-term progress that could drive a re-rating of the stock is unclear. 

“The fact management is still reconfirming a mid-term target of £90mn-£110mn [profit before tax] amidst continued poor trading just reconfirms to us that some realism is required before we can turn more positive,” said analysts with broker Liberum. 

The shares admittedly look cheap on just under 11 times consensus earnings for the current year, but we think this is fair value in light of low consumer confidence. Recent increases in sea freight rates, as well as the national minimum wage, present further cost challenges for Halfords.