Could this FTSE 250 stock be the next Rolls-Royce?

With its debt coming down, its free cash flow going up, and a recovery in demand for cruises, could FTSE 250 stock Carnival be due a major rebound?

| More on:

Image source: Rolls-Royce plc

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Rolls-Royce (LSE:RR) share price has been on a mighty recovery from its pandemic lows. The same hasn’t been true of FTSE 250 stock Carnival (LSE:CCL), though.

The two companies have a lot in common, in terms of their economics and their exposure to macroeconomic cyclicality. It’s therefore natural to wonder whether or not Carnival could be the next Rolls-Royce.

Business models

There are a lot of similarities between Rolls-Royce and Carnival. Both are heavily dependent on travel demand, both have high fixed costs, and both have the same issues with things like inflation driving up prices.

As a result, it’s not surprising that both saw their total debt jump significantly during the pandemic. With most of their operating costs intact, but most of their revenues gone, borrowing became the only way to stay solvent.

Rolls-Royce vs. Carnival Total Debt 2014-24


Created at TradingView

The problem is that this kind of balance sheet damage can weigh on margins. Higher debt means higher interest payments, which in turn weighs on profitability. 

Both companies are making progress in bringing their debt back down to pre-pandemic levels, but Rolls-Royce is further ahead. As Carnival catches up, there’s a chance its earnings – and share price – could get a boost.

Free cash flows

The thing that really jolted the Rolls-Royce share price into life was the return of travel demand. This began to kick free cash flow into life, which allowed the company to start reducing its debt.

Demand for cruises has also surged to pre-pandemic levels, though. And while it hasn’t fully recovered yet, Carnival’s free cash flow has also been rising sharply over the last couple of years.

Rolls-Royce vs. Carnival Free Cash Flow 2014-24


Created at TradingView

This has the power to begin a positive cycle for the business. Higher free cash generaion allows the company to reduce its debt, which should boost its credit rating, leading to lower debt costs and more free cash generation.

That’s what has been happening with Rolls-Royce, causing the share price to jump 172% over the last year. And while the Carnival share price is up 42%, it hasn’t had the same recovery.

Operating expenses

The obvious question is why Carnival shares haven’t fared as well as Rolls-Royce. The answer that stands out is the company hasn’t taken as drastic action to bring down its costs. 

Both during the pandemic and under its new management, the FTSE 100 engine manufacturer has been attempting to become more efficient. Operating costs are now below their pre-pandemic levels.

Rolls-Royce vs. Carnival Operating Expenses 2014-24


Created at TradingView

Carnival hasn’t managed to achieve the same efficiencies. Its operating expenses are still significantly higher than they were before the pandemic, which is weighing on margins and profits – and thus the share price.

This looks like the biggest difference between the two companies. For all their structural similarities, one has taken drastic action to cut costs and the other hasn’t. 

A buying opportunity?

Demand for cruises has recovered just as strongly as air travel. But the Carnival share price hasn’t produced the same explosive gains since the lifting of the travel restrictions that the Rolls-Royce share price has. 

The company is clearly in the process of bringing down its debt. But with operating costs still at much higher levels than 2019, I think the recovery in the stock could be much slower.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Is the Amazon share price primed for a drop?

The Amazon share price has been on a tear for the last year, but can this trend continue? Gordon Best…

Read more »

Photo of a man going through financial problems
Investing Articles

Down 15% in a week! What’s gone wrong with the National Grid share price?

The National Grid share price isn't supposed to crash but now it has. Harvey Jones is wondering whether to take…

Read more »

Group of young friends toasting each other with beers in a pub
Investing Articles

Taylor Wimpey just paid me £158.78. I’m aiming to turn that into a £100k yearly second income

Harvey Jones says small, regular dividend payments can turn a few pounds into a mighty second income, if he gives…

Read more »

A pastel colored growing graph with rising rocket.
Value Shares

These FTSE 250 shares are tipped to rise 14% to 18% in the next year!

Looking for the best FTSE 250 momentum shares to buy? Here are two that City analysts expect to soar in…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Lloyds’ share price is up 20% in 3 months! How high can it go?

Lloyds’ share price has ripped higher recently. Here, Edward Sheldon provides his view on the level it could potentially climb…

Read more »

Investing Articles

Why the Rolls-Royce share price could continue to outperform

The Rolls-Royce share price keeps moving forward, but this Fool thinks it's still behind where it ought to be after…

Read more »

Fireworks display in the shape of willow at Newcastle, Co. Down , Northern Ireland at Halloween.
Investing Articles

The City expects explosive growth in earnings from this almost-penny stock

It’s rare to find earnings predictions as robust as those for this not-quite-a-penny stock, so I’d research and consider it…

Read more »

Investing Articles

As earnings rise 600%, is Nvidia still the best AI stock to buy?

With the supply and demand equation still looking strong for Nvidia, is the stock still the best AI opportunity for…

Read more »