As the market reaches a new all-time high, cruise stocks continue to trade at distressed levels. While the rapid testing system will certainly help cruise liners to minimize the risk of the spread of COVID-19 on its ships, the industry’s future still looks grim. As one of the biggest cruise lines in the world, Norwegian Cruise Line (NYSE:NCLH) will continue to burn cash and raise even more debt in the following months in order to stay alive. While its stock might slightly rise on the positive news about the development of a COVID-19 vaccine, we believe that the opportunity cost of holding its shares is too high, and it’s better to avoid the company, as there’s every reason to believe that it will trade at distressed levels for a while.
Earlier in July, the CDC extended its no-sail order that was enforced in March and banned any cruise liners from operating in the United States waters until September 31. As a result, Norwegian Cruise Liners, along with other companies, decided to resume its operations only in late autumn. To prepare for the reopening, Norwegian Cruise Liners, along with Royal Caribbean (RCL), decided to create a Healthy Sail Panel, the goal of which is to work on safety measures that should prevent the outbreak of the virus on cruise ships. While it’s certainly a good initiative, there’s no guarantee that cruise liners will be able to sail at all in the upcoming months. At the beginning of August, 60% of Norwegian Cruise Liners passengers already requested cash refunds for canceled trips amid the risk that the regulators will once again extend the no-sail order to the further date. While Norwegian Cruise Line is not at immediate risk of becoming insolvent, there’s every reason to believe that its stock will trade in the distressed territory in the next few months and the recovery to its pre-COVID-19 profitability levels will be long and painful.
As expected, Norwegian Cruise Line recently had the worst quarter in its history, since all of its ships were docked in various ports around the globe. In Q2, the company’s revenues declined by 99% Y/Y to $16.93 million, below the consensus by $6.24 million, while its net loss for the period was $715.2 million. In addition, its adjusted EBITDA from April to June was -$393.1 million.
At the end of June, Norwegian Cruise Line had pro forma liquidity of $2.8 billion, while its total debt was $10.3 billion. Since its operations were halted in March, the company had no other choice but to issue new shares and raise more debt to stay alive. In March, May, and July, Norwegian Cruise Line diluted its shareholders by offering an additional stock, while, at the same time, it used a large portion of its fleet as collateral in order to raise money through the issuance of convertible notes at a yield in the range of 5% to 12%.
The problem is that the additional boost of liquidity will not stop the bleeding. Currently, the company burns around $160 million per month on fleet maintenance, interest expenses, taxes, and wages. In addition, such a cash burn rate will remain at the same level in Q3, since the company’s operations are still halted, while its interest expense is only increasing due to the issuance of new debt. In Q2 alone, interest expenses increased to $114.5 million for the quarter against interest expenses of only $66 million for the same period last year.
In addition to all of this, Norwegian Cruise Line has the worse balance sheet in comparison to its competitors Carnival Corporation (CCL) and Royal Caribbean. The cruise line has less tangible equity on its books, and its tangible book value per share is only $15.60. Carnival Corporation and Royal Caribbean, on the other hand, have tangible book value per share of $24.91 and $36.79, respectively. At the same time, Norwegian Cruise Line has the worst margins among the three of them, and it’s hard to justify its current market cap of nearly $5 billion, considering that it made less than $20 million in the last quarter.
Source: Capital IQ
Going forward, there’s every reason to believe that the Norwegian Cruise Line will continue to burn cash on a daily basis. While the company is likely going to implement a rapid test system on its ships, there’s no guarantee that the breach of the protocol will not happen. At the end of July, a cruise ship of Hurtigruten cruise company had an outbreak of COVID-19, as some protocols were breached, while, at the beginning of August, another cruise liner of the SeaDream cruise company was infected. All it takes is one person to infect the rest of the ship, and when cruise liners resume their operations, there’s also a risk that some of its ships could experience an outbreak like on those two cruise liners. If that happens on one of Norwegian Cruise Line ships, there’s every reason to believe that its stock will tumble like it did earlier this year.
Another problem is that lots of ports and borders around the globe are currently closed. The Bahamas and Cayman Islands banned the entry of cruise liners, while the EU is closed to most foreigners. Also, after the outbreak of COVID-19 on those two ships that were mentioned above, the government of Norway decided to ban the entry of large cruise ships.
In addition, the upcoming flu season, along with the resurgence of COVID-19 across the globe, creates the possibility of an additional extension of the no-sail order by the CDC for the rest of the year, as the number of new cases around the world increases by over 200,000 every day.
While the pandemic will undoubtedly end at some point, cruise liners will emerge from it with lots of debt. In addition, the recovery to the pre-COVID-19 profitability levels will take years, and most ships are likely going to operate at a reduced capacity in the near term. For that reason, it’s hard to justify owning Norwegian Cruise Line shares, since the company is likely going to trade in a distressed territory for a while, while the opportunity cost of holding its stock is too high. By having a negative outlook and a speculative rating, we believe that the Norwegian Cruise Line is uninvestable at this stage.
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