Investors’ Chronicle: Wise, Carnival, Polar Capital

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BUY: Wise (WISE)

The payments company is now receiving interest on its customer cash, writes Arthur Sants.

International payments business Wise is one of the few companies actually benefiting from the interest rate hikes. The company can now receive returns on the customer cash it has lying around. In the 12 months to March, it made £118mn of interest income, against a loss of £2.8mn the year before.

This contributed to a 73 per cent year-on-year increase in income to £964mn. This was ahead of the growth guidance of between 68 per cent and 72 per cent it issued back in January. The interest rate income doesn’t come with any extra cost, so it is dropping straight through to profitability, meaning the cash profit (Ebitda) margin rose 2.9 percentage points to 24.7 per cent.

Wise prides itself on offering cheaper transaction costs than banks so will look to return some of the extra interest income to users in the form of lower prices. However, the company expects margins to stay permanently above 20 per cent and says the margin should be ahead of its previous 2024 target.

It is not just interest rates driving growth, though — active customers also rose 34 per cent. Promisingly, 66 per cent of new customers joined through word of mouth, meaning it shouldn’t need to invest as much in customer acquisition initiatives. Yet marketing costs did increase by 3 per cent to £37mn. And the imperative to keep updating its technical capabilities saw R&D expenditure rise by 71 per cent.

Interest rates may not be far from their peak, so earnings growth could slow in the coming years. Peel Hunt is expecting adjusted earnings per share of 18.6p in 2024, giving a price/earnings ratio of 27. This is expensive, but customer growth has accelerated from last year’s 24 per cent and rising immigration will only drive more cross-border transactions.

SELL: Carnival (CCL)

The company set out new key performance indicators as it benefits from improved demand, writes Christopher Akers.

Miami-based Carnival’s shares hit a three-decade low last September, but investor sentiment had turned a corner in advance of the results. The share price has risen by more than 60 per cent year-to-date as expectations of a rampant cruise sector recovery have grown to new heights. But the more than 10 per cent markdown on results day, despite a guidance upgrade and growth across a range of other metrics, suggested that the market was expecting too much, too fast. Analysts at Truist Securities said the reaction was a “sell on the news” moment.

Carnival’s postings were certainly further evidence of the rebound in cruise travel demand after the decimation caused by the pandemic. Revenues in the second quarter were a company record, as were bookings for future sailings and customer deposits.

There were fears in the not too distant past of a permanent levelling off in travel demand, but by this point this hypothesis can be set aside. The Cruise Lines International Association forecasts that cruise passenger volumes this year will be 6 per cent ahead of pre-pandemic levels.

Carnival’s occupancy rate came in at 95 per cent in the period and improved to 98 per cent in the second quarter. The company said that its advanced booking position for the rest of the year “is near the high end of the historical range”, a good position to be in given ticket prices are pricier than in 2019.

The good news allowed management to increase its cash profit guidance for the year to a range of $4.10bn-$4.24bn. 

But despite financial progress and positive signs for consumer demand, the debt overhang and liquidity issues at Carnival simply can’t be ignored. While the company has paid down more than $1bn in variable rate debt since February, the huge debt pile is a constraint. Principal payments on outstanding debt will rise over the next few years to $4.5bn in 2026, and the net interest expense in the first half was an eye-watering $1.04bn.

Analysts at Moody’s noted last autumn that “free cash flow available for debt reduction will continue to be constrained by rising interest costs and new ship commitments”. Rates have, of course, risen significantly since then and variable rates apply to around a fifth of the company’s debt.

The rating agency assesses Carnival’s debt at B2 negative, which it describes as speculative and risky. The company hopes to reach investment grade gearing levels by 2026.

Elsewhere, some disconcerting comments in the company’s outlook statement may have impacted the share price movement. Management said full-year cruise costs would be higher than it expected in March due to “a slower expected ramp down in inflationary pressures” and that incentive compensation and advertising investment costs will rise. 

Whether Carnival can achieve the key performance indicators in its new “sea change programme”, which include hitting an adjusted return on invested capital of 12 per cent, remains to be seen. But for now, we have no plans to get onboard.

HOLD: Polar Capital (POLR)

The tech-focused fund manager endured another torrid year, though there were signs of improvement in some areas, writes Julian Hofmann.

Polar Capital had flagged much of the bad news over its fund outflows in its April trading update, which is why the market’s reaction to an average 14 per cent decline in assets under management (AUM) was reflective, rather than hysterical. In fact, investors seemed to take comfort from the news that parts of the fund manager’s investment performance had improved.

It was noticeable that investors used the opportunity to chase higher interest rates, which meant net redemptions hit £1.5bn. Fund closures took £500mn off AUM, with the general market decline and poor investment performance explaining the rest of the £2.9bn annual reduction in assets. Lower average AUM also meant a 17 per cent decrease in management fees, with a magnified knock-on effect for pre-tax profits.

There was evidence of recovery in certain parts of the business, however. Polar’s healthcare funds saw neutral redemptions, with £223mn of subscriptions broadly matched by redemptions in other areas. Better sentiment for UK companies saw funds flowing into the Polar Capital UK Value Opportunities Fund, while there was a similar story with emerging market strategies.

It is a definite issue that the unprecedented bull market in 2021 has created some awkward comparators for Polar Capital. It is a positive, however, that the company has settled a long-running legal dispute with FPA over the Phaeacian transaction, which explains part of the £6mn of higher-than-expected costs. Broker Numis expects a forward price/earnings ratio of 12.9, with a “paid to wait” dividend yield of 9 per cent for 2024.