Carnival Corporation in 2017 -- Risks vs. Potential Rewards

Princess Cruises, a subsidiary ofCarnival Corporation(NYSE: CCL), has been fined$40 millionfor dumping waste into the ocean between 2005 and 2013, according to a Department of Justicefilingin December.Just two weeks after the DoJ's ruling was made public, however, Carnival posted Q4 earnings above expectations and issued positive 2017 booking trends. Here are some of the risks facing Carnival Cruise Lines, and also what opportunities it has for growth in the years ahead.

Image source: Carnival Corporation.

Risks ahoy

While the DoJ's ruling could continue to have an impact Carnival as it comes under more scrutiny and its year-over-year earnings growth is affected by the fine, this seems like an isolated incident and its impact seems already folded into Carnival's stock price. However, there are other risks facing the company and industry at large that could have a much more substantial impact on future earnings in 2017 and after. Potentialincidents on ships, political or economic insecurity in some of the popular cruise destinations, and uncontrollable safety concerns -- as seen in the fear of Zika virus in the Caribbean in 2016 -- all could have a material impact on the number of passengers booking cruises.

However, one of the biggest financial risks to Carnival, as well as its competitors -- such asRoyal Caribbean(NYSE: RCL) andNorwegian Cruise Lines(NASDAQ: NCLH)-- is rising fuel prices. The industry has benefited from low fuel prices for the past couple of years, which has helped increase margins, as fuel cost is a major expense for operating cruises. These companies use fuel derivative programs to mitigate some of that risk, but that doesn't mean they're free from paying higher prices if fuel prices do rise in the year or years ahead. These cruise lines are investing in alternative-fuel vessels -- Carnival is in the process of building three ships now that run on liquefied natural gas -- but it will be a long time before this technology is powering a sizable part of any company's fleet.

A rising tide

Regardless of those risks, the cruise industry itself seems to be growing nicely, according to the Cruise Lines International Association's2017 Cruise Industry Outlook. The report claims that passenger numbers on cruises worldwide rose 4.3% in 2016, year over year, and are expected to rise 4.5% more in 2017, to over 25 million.

The U.S. is still the largest market, making up nearly half of all cruise passengers worldwide. One of the main drivers of this growth seems to be an aging and relatively wealthy population in the U.S., though younger generations are increasingly becoming cruise-ship passengers and are being targeted in marketing efforts. Going forward, growing consumer confidence in the U.S., which hit a 12-year high in late 2016, could help this segment to grow more in 2017.

Image source: Carnival Corporation.

China is still a much smaller market than the U.S., with just under 1 million cruise passengers from there last year. Still, it continues to look like a growth opportunity for cruise lines, with a rapidly expanding middle-class population that is increasingly focused on travel. Each year, these cruise companies are deploying more and more ships to cruise routes around China.

Carnival in 2017 and beyond

For the fiscal year 2016, ended Nov. 30, the company grew its total revenue -- made up of tickets, onboard sales, and tours -- by 4.3% year over year. Net income rose a much more impressive 58% over 2015, thanks in large part todecreasing fuel costs and lower losses on fuel derivative contracts than in the year before. However, the company could face some struggles in 2017, particularly because it predicts higher fuel costs.

Carnival management sees strong bookings going into 2017, saying that "cumulative advance bookings for the first three quarters of 2017 are well ahead of the prior year at considerably higher prices" and adding: "Since September, both booking volumes and prices for the first three quarters of 2017 have been running well ahead of the prior year." Still, with the combination of rising fuel costs and foreign currency impacts, it expects adjusted earnings per share of$3.30 to $3.60, compared with $3.45 for the full year of 2016.

Even though 2017 is expected to end flat, longer term it continues to look like a best bet on this growing industry.Carnival has by far the largest number of ships, with around 100 in sail now and more on the way. In addition, Carnival's valuation is in line with its peers, and other than its market-leading position in terms of cruise capacity, it also has a higher dividend, which it increased again in 2016, for a yield that now sits at 2.5%.

Data source: Yahoo! Finance.

Finally, Carnival has begun TV programming deals in which the company and its cruise operations will be featured in shows with various networks, which could help to drive more demand as Carnival shows off its ships and destinations to millions of potential cruisers. I can't say I'll be watching any of these shows, but in 2017 and beyond I will be watching how Carnival can gain from the growing cruise market, as well as for signs that this industry-leading company can take advantage of its dominant position to grow margin and earnings further in the years to come.

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Seth McNew has no position in any stocks mentioned. The Motley Fool recommends Carnival. The Motley Fool has a disclosure policy.