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Carnival shares surge 10%. Is it time to cash in your gains?

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Carnival shares soared Friday amid a wider stock market rally that drowned out the cruise line operator’s disappointing earnings. Is it time to cash in on those gains and sell the stock?

Carnival Corp. shares climbed almost 10% after the cruise line operator said it expects occupancy to improve throughout this year, fueling optimism that the company can weather an economic downturn.

The company, which has been losing money since the start of the pandemic, said it expects to report positive adjusted earnings before interest, taxes, depreciation and amortization in the third quarter. It posted positive cash flow from operations in the three months through May 31, according to its press release.

Shares advanced amid a wider market rally and gave a boost to rivals Royal Caribbean (RCL), up 15% on the day, and Norwegian Cruise Line (NCLH), up 14%.

But the optimism drowned out negative news that Carnival now expects to report another loss in the third quarter after second quarter revenue missed analysts’ estimates. That could make the stock’s advance a good exit point. Here’s why.

Losses continue

While increased occupancy helped Carnival boost revenue by almost 50% in the second quarter from the previous three months, the US$2.4 billion total still trailed the US$2.6 billion average estimate of analysts, according to data published on Yahoo Finance.

Adjusted net loss narrowed to US$1.87 billion in the second quarter, from US$2.04 billion a year earlier. The company’s third quarter loss forecast is a reversal from its profit guidance given in February.

Should investors take advantage of the rally to sell Carnival shares?

It may not be a bad idea to sell your shares in a company that’s counting on the revival of the travel to return to profit at a time when other firms are bracing for a recession.

SmartConsensus, which compiles ratings from analysts at Argus, Market Edge and Thomson Reuters, has a “sell” rating on the stock. Charles Schwab also recommends selling the stock, noting that its grades for growth, quality, sentiment, stability and valuation are all negative.

Refinitiv gave Carnival a fundamental rating of 1, which is significantly more bearish than the hotels and cruise lines industry average of 4.3. The company’s gross margin has stayed below the industry average for the past five years, it said.

Morgan Stanley estimates the company’s cash burn rate rose to US$600 million a month, from US$500 million in the first quarter. The bank’s analysts have an “underweight” rating on the stock, meaning investors should hold less shares in the company than its weighting in indices.

Carnival’s mountain of debt raises concern

The company’s debt has more than tripled to US$35 billion as of May 31, from about US$11.5 billion at the end of fiscal year 2019. Carnival has been burning cash as it struggled to stay afloat after the global pandemic prompted travel restrictions, forcing cruise lines to suspend operations.

Carnival shares have been weighed down by its huge debt at a time when borrowing costs are rising. As of May, the company’s principal payments on maturing debt this year reached US$1.3 billion and US$2.8 billion is due next year. Interest expense for the rest of 2022 is expected to reach US$800 million.

“While CCL shares now trade below our recently lowered price targets, we remain concerned about its high leverage / refinancing needs, high industry supply growth dampening pricing power, and the macro outlook,” Morgan Stanley’s Jamie Rollo, Adrija Chakraborty, Rowan D Quill said in a note published after Carnival released its earnings report.

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Author Luzi Ann Javier doesn’t own Carnival shares.

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