Over the past six months, Norwegian Cruise Line’s shares (currently trading at $23.38) have posted a disappointing 5.9% loss, well below the S&P 500’s 6.4% gain. This was partly due to its softer quarterly results and might have investors contemplating their next move.

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Why Is Norwegian Cruise Line Not Exciting?

Even with the cheaper entry price, we're sitting this one out for now. Here are three reasons why you should be careful with NCLH and a stock we'd rather own.

1. Inability to Grow Passenger Cruise Days Points to Weak 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.

Over the last two years, Norwegian Cruise Line failed to grow its passenger cruise days, which came in at 6.29 million in the latest quarter. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Norwegian Cruise Line might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

2. Cash Burn Ignites Concerns

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.

While Norwegian Cruise Line posted positive free cash flow this quarter, the broader story hasn’t been so clean. Over the last two years, Norwegian Cruise Line’s demanding reinvestments to stay relevant have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 5%, meaning it lit $5.00 of cash on fire for every $100 in revenue. This is a stark contrast from its operating margin, and its investments in working capital/capital expenditures are the primary culprit.

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 $504.5 million of cash over the last year, and its $13.76 billion of debt exceeds the $184 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

Norwegian Cruise Line’s business quality ultimately falls short of our standards. After the recent drawdown, the stock trades at 10.5× forward P/E (or $23.38 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at our favorite semiconductor picks and shovels play.

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