Norwegian Cruise Line: Oversold Company With Downside Risks (NYSE:NCLH) (2024)

A lot of bad things have happened to the industry Norwegian Cruise Line Holdings Ltd. (NYSE:NCLH) belongs to. The pandemic made many operators delay or cancel their bookings. So, there were no cash inflows for 2020 and most of 2021. At the same time, there were cash outflows in order for the companies to maintain their cold-stacked ships.

The pandemic is almost over right now, but the fuel costs have gone up and the companies' balance sheets are worse than they used to be before the pandemic. Many companies, including Norwegian Cruise Line, diluted their shares. But the stock prices in the industry already more than take this into account.

Investing in Norwegian Cruise Line Holdings, therefore, does not look too risky, but potential stock buyers should remember its debt level and equity dilution. Let me explain this in more detail.

Debt level

Quite objectively, the company cannot boast much performance excellence right now. Two years of losses, declining revenues, and high debt are obvious alarm bells for any conservative investor.

The debt ratios have sufficiently deteriorated, whereas the equity (assets - liabilities) has also declined. But the company did a good job of raising cash. According to the company's earnings press release for the first quarter of 2022:

"the Company’s total debt position was $13.6 billion and the Company’s liquidity was $3.1 billion, consisting of cash and cash equivalents and a $1 billion commitment available through August 15, 2022."

The Norwegian Cruise Line's management organized a debt exchange but also issued more shares, thus diluting its existing stockholders. The proceeds were used to buy back all outstanding 12.25% senior secured notes due 2024. What is more, even the 10.25% 2026 senior secured notes were bought back by the company. Obviously, with the existing $3.1 billion, the company can meet its principal payments on debt maturing in 2022. All that implies the company's debt is manageable right now.

We can also say that Norwegian Cruise Line's debt is a direct result of the pandemic. There is a legal term called "Act of God" that depicts a one-off event no one could have predicted. It clearly illustrates the recent coronavirus-induced lockdowns that heavily impacted the cruise-line industry and Norwegian Cruise Line. As the pandemic is almost over, the company's debt should also decrease.

We can see that before the pandemic the total long-term debt was even below $7 billion, whereas now it is almost twice as much. The long-term debt will not return to its previous level overnight, of course. But it will gradually fall down, in my opinion.

Revenue and profit figures

By no means were the recent first-quarter results brilliant. The net loss of $(1.0) billion, however, was substantially lower than the net loss of $(1.4) billion that had been recorded a year ago. The operating expenses, meanwhile, also increased by a whopping 266.1%. But this is mainly due to the resumption of cruise voyages, which also made the revenue figure total $521.9 million vs. $3.1 million for the same period a year ago.

The operating expenses also rose because of higher wages, fuel, food, logistics, and direct variable costs of fully operating ships. In 2022, Norwegian Cruise Line also saw an increase in repair and maintenance costs, including planned Dry-docks.

Interesting is also the fact Norwegian Cruise Line's EPS in 1Q2022 totaled ($2.35), whereas the EPS for 1Q2021 was $(4.16). This is not, however, only due to Norwegian Cruise Line's improved performance in the last quarter. This was mainly due to high equity dilution happening in 2021. I will explain this later in more detail.

But, first of all, I see this 2020 - 2022 performance as something extraordinary, almost a one-off failure. The fact the company resumed cruises should make its financial matters much better than they used to be during the pandemic.

As can be seen from the graph below, Norwegian Cruise Line's revenue figures grew steadily before the 2020 catastrophe.

The same can be said about the company's EPS history. From year 2013 to 2019, the company's earnings showed slow but very stable growth, which is encouraging.

Equity dilution

The company also used to buy back its shares before the crisis. But soon after the outbreak, the company began diluting its shareholders.

After 2016, the number of shares declined due to the share buybacks. But, after 2020, just in two years' time the number of shares almost doubled. That is a highly negative factor for the company's shareholders. However, are not the shares already too oversold? In other words, don't they already take all this into account?

Valuation

At first sight, it appears the stock is not undervalued as far as the valuation multipliers are concerned. Although the stock has corrected significantly, the price-to-sales (P/S) ratio has not.

The same is true of the price-to-book (P/B) ratio. Although the company's debt has risen significantly, the company does not look like a bargain as far as the P/B ratio is concerned. An indicator above 3 suggests slight overvaluation. Such overvaluation would have been logical for a company with a perfect balance sheet and growing profits.

However, we can clearly see Norwegian Cruise Line Holdings stock is trading near multi-year lows.

Before the pandemic, the stock used to trade close to $60, whereas now it is near $15. At the same time, the worst might be over now. If we assume the revenue and profit figures have returned to the previous levels and take the dilution effect into account, the stock should trade close to $30.

The worst may be over now - insider buys

The thing is that in most countries the coronavirus-related lockdowns seem to be over right now. For example, about a week ago, China lifted its Covid restrictions. That is why, in my view, there will not be serious troubles in terms of demand for Norwegian's cruises. So, the revenue and the EPS figures should improve. The debt level should also go down. The only problem is the share dilution effect. However, the company would also probably be able to resume its buyback program.

My colleague Petar Mirkovich wrote about the lack of stock purchases by the company's insiders. The article was published in the beginning of April. At the time, there were no insider buys, indeed. However, quite recently there was some buying of shares by executives.

I suppose right now the share price seems to be reasonable for Norwegian's executives as opposed to March and April levels.

Downside risks

There are also downside risks for Norwegian. To start with, the fuel costs are very high right now. This is quite an upside for Norwegian's operating expenses and, therefore, a downside for the company's profits. What is more, cruising is a luxury service. If there is a recession, many people will be unable to afford booking a cruise. Then, there is a risk monkeypox might also become a pandemic. But most importantly, Norwegian Cruise Line has suffered greatly from the pandemic-related crisis. The balance sheet is imperfect, although I believe it has recovery potential. The equity has been diluted, whereas the company's stock is quite volatile.

Conclusion

Although Norwegian Cruise Line's stock does not look like a good addition for a conservative investor's portfolio, it certainly has some growth potential. It does not look plausible that the stock price will return to its previous levels seen before the pandemic within a year. But a share price of around $15 does not look fair, either. The cruising industry is a luxury which many people would be unable to afford, especially during a recession. But it seems the worst is over for Norwegian, given the coronavirus-pandemic is almost over.

A research analyst and a freelance writer looking for value investment opportunities. I have several years of investing experience. I am mostly interested in writing about bargain stocks of large companies. My interest is not limited to American companies but extends to firms operating in other countries but listed on US stock exchanges.