Carnival (CCL -7.60%) stock has been one of the biggest winners on the market this year. However, investors in the cruise line stock seemed to catch a case of seasickness after its second-quarter earnings report came out on Monday morning.

Shares finished down 7.6% Monday after trading down double digits for much of the session. That pullback was a bit of a surprise as Carnival actually beat estimates on the top and bottom lines. The world’s largest cruise operator posted a 105% jump in revenue to $4.91 billion, ahead of expectations at $4.77 billion. That was a record for Q2 revenue, the latest sign that the company continues to rebound strongly from the pandemic.

Other bright spots included record customer deposits at $7.2 billion, beating the previous pre-pandemic record at $6 billion, and another all-time high in total bookings.

On the bottom line, Carnival continued to move in the right direction though the company is still facing stiff headwinds from its heavy debt burden, which jumped during the pandemic. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) came in at $681 million, toward the high end of its guidance, and a significant improvement from a loss of $928 million in the quarter a year ago.

Cash generation was also positive as adjusted free cash flow was $625 million, up from a loss of $487 million a year ago. However, on a generally accepted accounting principles (GAAP) basis, the company posted a loss of $407 million, or $0.32 a share, which was slightly better than the consensus at a loss of $0.34. Interest expense of $542 million was the main reason for the loss.

For the full year, Carnival raised its adjusted EBITDA guidance to $4.1 billion to $4.25 billion, and the company is heading into its seasonal peak in Q3, expecting $1 billion in adjusted net income for the current quarter.

Image source: Getty Images.

Why Carnival stock fell Monday

Despite solid results and an increase in guidance, the stock still pulled back as investors seemed to be saying that good news was already priced into the stock. Even after today’s pullback, the shares are still up 81% year to date as investors and Wall Street analysts have responded to strong consumer demand for cruises as the safety concerns of the pandemic have started to abate.

CEOs including Carnival’s Josh Weinstein have happily touted the recovery, and Weinstein provided this view on the market texture in the second-quarter earnings report:

Our momentous wave period, typically a first-quarter event, started in record-breaking fashion at the end of the fourth quarter, set a record in the first quarter, actually accelerated in the second quarter and has continued into the third quarter. Booking volumes have been tremendous and we are gaining momentum with favorable pricing trends, which reflects improved commercial execution and returns on our advertising investments.

Even with strong demand, however, Carnival still has a long road to travel to recover from the pandemic as it took on significant debt during the global health crisis and diluted shareholders, meaning it will take more than a recovery in operating profits to return to its previous level of shareholder value.

The company is making progress on easing its debt burden as it prepaid more than $1 billion in short-term, variable-rate debt, though it still has about $7.5 billion in debt due by the end of 2025.

Is Carnival stock a buy?

While the cruise line stock has soared this year, it’s still down significantly from historical levels. The stock has fallen by more than 80% from its all-time high in 2018 and is off more than 70% from where it was trading at the start of 2020 before the pandemic started.

That’s a sign that there’s still considerable upside if the company can get its financial house in order. Management aimed to reassure investors on that end by introducing its SEA Change program, a set of 2026 goals that include increasing EBITDA per available passenger berth day/available lower berth day (APBD/ALBD) by 50% and more than doubling adjusted return on invested capital (ROIC) to 12% from 2023 to 2026. The company also said it expected to approach an investment-grade leverage ratio by the end of 2026, which is generally understood to mean a debt-to-EBITDA ratio of 3 or less.

If Carnival can hit those goals, the stock should be a winner over the next few years. It’s unclear if the current wave of record demand will persist, but trends like remote work and baby boomers entering retirement should support continued revenue growth for Carnival. 

The stock remains risky, but at this point, there is significantly more upside than downside, especially if the current wave of record demand continues.

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