Carnival’s Europe exposure biggest factor in profit dip

Carnival Corp. finds itself behind expectations in the
second half of 2019 as it tries to mitigate setbacks from a “confluence”
of events.

The company told investors on June 20 that weakness in the
next six months, especially in business from continental Europe, could mean
$242 million less in profits than what was forecast to start the year, a rare
second profit reduction in one year for the company.

The biggest single issue is in Europe, specifically with
cruises bought by Europeans.

But some of the rest of the weakness will hit closer to
home, including the end of Havana as a cruise destination as of June 6 and an
Azipod propulsion system malfunction on the Carnival Vista that will sideline
it for much of July. 

Carnival’s Q2 net income dropped to $451 million, from $561
million in Q2 2018, and CEO Arnold Donald admitted to the potency of the issues
during the second-quarter earnings call.

“What’s happening right now is just a confluence of
events,” Donald said. “We’ve had them in the past, but we were able
to overcome them. This year, the confluence kind of overwhelmed us.”

Other lines also have some troubles, particularly with Cuba,
where Carnival’s exposure is relatively lower than that of its two publicly
traded counterparts, Royal Caribbean Cruises Ltd. and Norwegian Cruise Line
Holdings. 

But neither comes close to Carnival’s dependence on Europe
for guests. With its market-specific brands such as Aida Cruises, which markets
in German-speaking countries, and Costa Cruises, which primarily targets Italy,
France and Spain, Carnival gets close to a third of its guests from Europe,
according to analyst Patrick Scholes of SunTrust Robinson Humphrey, compared
with just 5% to 7% for the other two major cruise companies.

“For [Carnival] in Germany, demand has not been able to
keep up with new supply in its Aida brand,” Scholes wrote in an investor
note. “For Southern Europe (implies Costa brand), Italy is in recession,
and in France, the yellow vest disruptions have been headwinds to travel
demand.”

In addition, Donald said that resort destinations in North
Africa and Turkey that had been closed for several years because of political
issues have reopened and are priced lower than typical cruise vacations.

For the next six months, the underlying economic outlook for
Europe isn’t expected to improve, Carnival officials told investors.

That leaves Carnival with little choice but to manipulate
the levers of supply and demand to mend results.

On the supply side, Donald said Costa has already agreed to
sell two of its ships, the Costa Atlantica and the Costa Mediterranea, to a
joint venture Carnival Corp. has with the China State Shipbuilding Corp. 

Those ships had been sailing for Costa in China until they
were replaced by newer ships and then redeployed to Costa’s Europe fleet. As a
result, Costa’s Europe-sourced itineraries jumped by 14% in 2019, although none
from new tonnage.

“We’re evaluating further opportunities to optimize our
future performance, including accelerating demand and rightsizing capacity,”
Donald told analysts.

Demand stimulus translates into more marketing and promotion
in the second half. Donald added, however, that planned increases in
advertising will be offset by unspecified cost savings in other areas.

Costa’s task this year hasn’t been made any easier by the
fact that the brand hasn’t had a new ship to sell to European markets since the
Costa Diadema was delivered in October 2014, nearly five years ago.

In the meantime, Costa’s biggest competitor for southern
Europeans, MSC Cruises, launched the MSC Meraviglia, the MSC Seaview and the
MSC Bellissima in 2017, 2018 and 2019. Two of the three are sailing in the
Mediterranean, with the third deployed for the summer in northern Europe.

Costa expects to end its new-ship drought in November with
the advent of the 5,000-passenger Costa Smeralda, and Donald said that despite
the Italian recession, “the ship is booking very well so far.”

To what degree MSC is affected by weakening demand in Europe
is an open question since the privately owned company isn’t required to talk
about its finances. But MSC has made no secret in recent years of its desire to
diversify its sourcing in markets ranging from North America to China to South
Africa.

Cuba, Vista

Still, analysts don’t see Carnival’s problems in the second
half as a general softening of the industry.

“With the exception of Cuba, we strongly believe
[Carnival’s] headwinds are unique to Carnival,” Scholes said.

Carnival put the 2019 impact of the end of Cuba sailings at
$25 million to $37 million, most of it in the second half.

Carnival’s misfortune with the Carnival Vista will be
costlier, nearly as expensive as its woes in Europe, Carnival said.

The ship will miss three weeklong cruises from Galveston,
Texas, in July while the Azipods get new bearings. Carnival projects that the
resulting reduction in earnings could be between $49.5 million and $62 million.

Because of damage from a crane collapse in April at the
biggest drydock in the Grand Bahama Shipyard, Carnival could not take the Vista
there for repairs as it would usually do. Instead, it said it is completing
negotiations and planning with a “shipping vessel operator” on a
protocol “that will be a first-of-its-kind procedure.”

Carnival said more details will be forthcoming, but it plans
remain to return the Vista to service on July 27.

Analysts said the sum of the problems Carnival disclosed is
going to weigh on its stock price for the foreseeable future. Shares started
the year at $49.20 and reached $58 on Feb. 20 but now trade around $45.

The line reduced its earnings guidance after its first-quarter
earnings call in March because of negative impacts from fuel prices and
currency exchange.

At the time, Donald said demand from source markets in
Europe was flat to down.