Should Investors Climb Aboard Carnival’s Damaged Stock?

What would Warren do? It’s a question worth asking in light of the Costa cruise ship disaster and Warren Buffett’s oft-quoted advice to be fearful when others are greedy and to be greedy when others are fearful. Might the master be buying shares of Carnival Corp. (symbol CCL (opens in new tab)) at its newly discounted price? Did he snap up any of them on January 18, when they jumped 3.2%, to $30.55, a day after they plunged 13.7%?

No one knows, of course, and if Buffett were buying, we wouldn’t get confirmation for months. But there’s no question that Carnival might pop up on his radar screen. Carnival is large, profitable and generates a lot of cash. It’s a relatively simple business. And Carnival, as the world’s largest operator in what is essentially a duopoly -- Royal Caribbean Cruises (RCL (opens in new tab)) is the other major player -- enjoys a wide “moat,” which insulates it from intense competition, a key Buffett criteria. Then again, a company like Carnival may be too cyclical and too capital-intensive for Buffett’s taste (big boats cost big bucks).

For those who haven’t been paying attention, the Costa Concordia cruise ship, operated by Carnival’s Costa Crociere unit, capsized on January 13 off the coast of Italy. Eleven passengers are known to have died and 21 are still missing.

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The initial decline in Carnival’s share price was logical and predictable. The question is whether investors, who often sell first and ask questions later, overdid the disgorgement, creating an opportunity for the intrepid among them.

History shows that insightful, intrepid investors can cash in on catastrophes and scandals. Consider the BP oil disaster. In April 2010, BP’s Deepwater Horizon drilling rig exploded in the Gulf of Mexico, killing 11 workers and causing the worst offshore oil spill in U.S. history. BP’s stock, selling for more than $60 before the disaster, plummeted immediately and continued to fall through June of that year, hitting a low of $27.02 just a few weeks before the well was finally capped. Value-oriented investors who scooped up the stock in the summer of 2010 on the theory that the oil spill had done more damage to BP’s stock price than to its business have been well rewarded. BP closed at $44.56 on January 18.

Here’s a closer look at the Carnival situation. The Miami-based company estimates that insurance deductibles will trim earnings by $40 million, or $0.05 per share, for the fiscal year that ends next November. In addition, Carnival figures that the loss of business from the Concordia’s demise will lop off $85 million to $95 million in profits, or $0.11 to $0.12 per share.

Predicting other hits Carnival may take involves more conjecture. For starters, its insurance rates are bound to rise. The bigger question is how much the accident will hurt future bookings and how much Carnival will have to cut prices to lure travelers. The accident’s timing didn’t help: About one-third of cruise vacations are booked from January through March.

As a result, analysts have slashed their earnings estimates for Carnival. JPMorgan analyst Kevin Milota believes Carnival will have to offer deep discounts, so he cut his forecast by 21%, to $2.16 per share, and lowered his price target for the stock from $38 to $30. Morgan Stanley went further, hacking its 2012 earnings estimate by 30% and its price target from $41 to $27.

There’s still one other important risk to consider. The stricken Concordia is filled with half a million gallons of heavy fuel and marine gas oil. So far, there have been no reports of any spillage. But if the ship’s fuel tanks were to burst, the environmental damage could be profound. The shipwreck sits on part of the Tuscan Archipelago National Park, the largest marine protected area in Italy.

The modern cruise industry has experienced relatively few catastrophes, so it’s hard to say how long it will take Carnival’s shares to recover. Perhaps the closest parallel to the current situation came after the 9/11 terror attack, an event that damaged the travel industry severely. Carnival’s shares cratered some 40% in a week once trading resumed, but the stock recovered all of its losses within four months.

Carnival’s stock, which gained another 85 cents in early trading on January 19, looks reasonably priced but is hardly dirt-cheap. At the January 18 close, it sold at 12 times the $2.49 per share that analysts tracked by Thomson Reuters expect the company to earn on average in the current fiscal year. The problem is that the consensus figure is still too high. Using Milota’s $2.16 per share estimate, for example, Carnival’s price-earnings ratio is 14. That’s not outrageously expensive, but the P/E may be too high for a company with so many uncertainties surrounding it.

Our advice is to hold off purchasing Carnival shares until the picture becomes clearer for the company or until the shares drop a few more dollars. As for Buffett, he might not give Carnival a moment’s notice, but consider this. Adding it to his trophy case would give Berkshire Hathaway, the company he runs, a transportation trifecta: boats, planes (through its NetJets fractional jet ownership subsidiary) and trains (through its Burlington Northern Santa Fe unit).

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