Norwegian Cruise Line has had an impressive run over the past six months as its shares have beaten the S&P 500 by 5.2%. The stock now trades at $18.54, marking a 9.4% gain. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why do we think Norwegian Cruise Line will underperform?
We’re happy investors have made money, but we’re cautious about Norwegian Cruise Line. Here are three reasons you should be careful with NCLH, plus one stock we’d rather own.
1. Weak growth in passenger cruise days points to soft demand
Revenue growth can be broken down into changes in price and volume (for companies like Norwegian Cruise Line, our preferred volume metric is passenger cruise days). While both are important, the latter is the most critical to analyze because prices have a ceiling.
Norwegian Cruise Line’s passenger cruise days came in at 7.2 million in the latest quarter, and over the last two years, averaged 4.9% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability. 
2. Cash flow margin set to decline
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the next year, analysts predict Norwegian Cruise Line’s cash burn will increase. Their consensus estimates, according to S&P, imply its free cash flow margin of negative 5.6% for the last 12 months will fall to negative 10.4%.
3. Short cash runway exposes shareholders to potential dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Norwegian Cruise Line burned through $564.2 million of cash over the last year, and its $15.09 billion of debt exceeds the $256.5 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Norwegian Cruise Line’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Norwegian Cruise Line until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final judgment
We see the value of companies helping consumers, but in the case of Norwegian Cruise Line, we’re out. With its shares outperforming the market lately, the stock trades at 13.9× forward P/E (or $18.54 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are superior stocks to buy right now. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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