Norwegian Cruise Stock: More trouble on the horizon (NYSE: NCLH)

Norwegian Cruise Line Holdings Ltd. (NYSE: NCLH) is an American entertainment cruise giant that has had a very successful few years in the cruise business. Travel and leisure stocks were mostly hammered the past two years due to ongoing pandemic issues. Seemingly endemic within the industry, cruise stocks have come to the end of the day. With closures and travel restrictions in place, being literally shut down and with no ability to generate cash, cruise stocks have been fighting an uphill battle for a long time.

Yet with pandemic cases and deaths losing momentum in recent months, many countries have rolled back restrictions in optimism that the end of Omicron has brought the world one step closer to ending the entire pandemic. With that, many expect the long-awaited recovery in cruise stocks and a brighter future for the entertainment giants. However, is this really the case? We will share our views on the matter and attempt to answer why we believe Norwegian Cruise Line is still a long way from a meaningful recovery for its shareholders.

A new start for the Norwegian?

Norwegian Cruise Line’s entire cruise fleet of 28 ships has been docked for most of the past two years. During this period, with no cash-generating capability, the company had no meaningful way to finance its expenses other than through debt and equity financing. In the past year alone, the company has spent $2.6 billion on cash.

On the bright side, management was able to stabilize its finances by keeping expenses under control while ending the rise in debt. With part of the cruise fleet finally sailing, the company has started to generate much needed cash flow, which has further relieved finances. Additionally, management was able to build a relatively strong cash position of $2.70 billion, given the circumstances.

According to the last quarterly filing, the company had debt of $13.10 billion and net debt of $11.17 billion. This is a significant increase from its pre-pandemic debt level at the start of 2019, when the company had just over $6 billion in debt. In other words, the company had to raise $6.6 billion in debt to stay afloat. This means Norwegian was forced to double its debt following the shutdown of operations during the pandemic.

To put it into perspective, the company went from a running ratio of 0.20x and a quick ratio of 0.09x at the end of 2019 to a running ratio of 0.89x and a quick ratio of 0.78x. end of 2021. They went from having a manageable total debt/EBITDA ratio before the pandemic of 3.72x and a net debt/EBITDA ratio of 3.59x to a negative total debt/EBITDA ratio of 7.41x and a debt ratio net/EBITDA negative of 6.42 today.

The company’s pre-pandemic EBITDA to interest expense ratio was 7.40x, meaning the EBITDA generated could cover interest payments by more than seven times. Those days are long gone, as Norwegian Cruise Lines generated negative EBITDA of $489 million last quarter. The same ratio is now negative at 2.72x, as the company has to pay $178 million in interest payments.

It might not be so fair given that the company hasn’t done any business. If the cruise entertainment industry were to return to normal at the end of 2022 and 2023, it is not unreasonable to expect similar numbers to reappear, so we could compare the last quarter of positive EBITDA to charges quarterly interest rates today. We would arrive at an EBITDA/Interest expense ratio of 2.08x.

The aggregate cumulative position reserved for the first half of 2022 is below the extraordinarily high levels of 2019, while the second half is in line with the comparable period of 2019 and all periods at higher prices. – ~70% of the cumulative reserved position for the year 2022 are cash reservations compared to FCCs – ~60% of the cumulative reserved position for the year 2022 are cruisers loyal to our brands

NCHL – 2021 Annual Presentation

All of this serves to underscore the fact that the company urgently needs to get its cruise fleet going again and sailing again, and would otherwise face serious risks in terms of servicing its debts and staying afloat. Fortunately, better days seem to be ahead for Norwegian Cruise Line, as it has been announced that by May 2022, their entire fleet is supposed to be ready to sail if no major disruptions occur. This means we could see fourth quarter results in line with what the company would have generated before the pandemic, possibly signaling a fresh start for Norwegian.

Again, this whole situation was largely out of anyone’s hands and, in general, what happened to an otherwise good company is a real tragedy. This can be seen by looking back at the excellent financial results the company has generated over the years. However, management and shareholders must face the consequences, and those consequences have, in fact, been terrible.

The cost of equity financing

As previously explained, the company was burning through large amounts of cash and had to find a way to pay the bills. Apart from the high leverage that we have already discussed earlier, the management has also resorted to raising capital by issuing new shares of the company.

The sad reality is that the company demonstrated a wise use of capital by executing well-coordinated stock buyback programs during the 2014-2019 pre-pandemic period. During this time, the company reduced the number of shares outstanding to 212.7 million shares, from 227 million before the execution of the programs. Management ended up buying back almost 7% of the shares during those years.

At the end of the fourth quarter of 2019, the company had 213.20 million shares outstanding. That number grew to more than 419.09 million shares as the company sought capital during the pandemic. The total number of shares outstanding increased by almost 206 million. With some math on the back of the paper, if we assume the average share price was around $20, we can conclude that the company raised over $4.1 billion through equity financing.

The effect of equity financing is arguably even more damaging to the company’s long-term prospects than increased debt. Still, you could say that management’s hands were tied here and they had no other real solutions. Moreover, their competitors seem to have largely done the same, as was the case with Carnival Cruise Lines (CCL) and Royal Caribbean (RCL).

However, if we compare the degree of dilution that has occurred in the rest of the industry, we can conclude that Norwegian management relied the most on equity financing. So far, management has diluted shareholders to 95%. In other words, we have twice as much Norwegian Cruise Lines stock compared to pre-pandemic levels. Management’s primary focus over the next few years is likely to be the battle to deleverage the balance sheet, which means it will likely be a long time before some sort of meaningful buyback program can be executed again.

No vote of confidence from leaders

One very interesting thing we can observe when analyzing “post-pandemic” cruise stocks is the lack of confidence from senior management in the future performance of the stocks. We have witnessed what I consider to be a very strong and noticeable lack of executive insider buying across the industry, which is a message in itself.

The whole line of Norwegian executives has been selling out ever since the pandemic hit. This seems somewhat surprising, given that the stock price is significantly reduced by more than 65% from pre-pandemic levels.

We can recall an interesting quote from Peter Lynch at this point: “Insiders may sell their stocks for any number of reasons, but they buy them for only one: they think the price will go up.” In my opinion, no one but the executives and the rest of the senior management has a better vision and a sharper view of the future of the company. The fact that no one is buying yet should send a strong message of distrust into the company’s future. Let’s look at two cases of executives acting differently.

In 2021, when shareholders reacted negatively to news of the WarnerMedia split, John Stankey of AT&T decided to buy back $1 million worth of company stock in a huge vote of confidence. Likewise, after Wells Fargo (WFC) shares fell more than 40% in 2020, new CEO Charles Scharf bought nearly $5 million worth of company stock. His company’s shares then more than doubled. If you believe a turnaround is imminent, there’s no better way to let shareholders know than to get your ass in the game.

Some Final Thoughts and Conclusions

Cruise lines got probably the worst deal of the pandemic from any travel and leisure company. Irrespective of their financial strength and actual performance, they have all been thrown under the bus by being unable to operate their cruise empire and burning through cash in the meantime. Companies have therefore been forced to rely on debt and equity financing, completely destroying their balance sheets in the process and making them look rather uninvestable.

While it is true that this situation is factored in to some degree, I would argue that a 65% discount from pre-pandemic highs is simply not enough to explain the doubling of debt and equities. in circulation of the company. Debt has not only become larger, but also more expensive, and as such will prove increasingly difficult to manage over the next few years, creating more headaches for management and shareholders.

All of this under the assumption that the company will establish some sort of pre-pandemic financial success over the next 3-5 quarters. In retrospect, the shareholders who jumped bridges as soon as the pandemic hit seem to have gotten the best or at least the least painful deal. It wouldn’t be unreasonable to assume that the stock will rally slightly as the macro headwinds dissipate and the early good results start to pile in; however, the real question is what happens next? Ultimately, I’d say it’s a fundamentally flawed company with little to offer potential investors.