Norwegian Cruise Line Holdings

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 1/5

Norwegian Cruise Line Holdings is a global cruise company operating a portfolio of cruise brands, offering diverse itineraries and travel experiences to customers worldwide.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Norwegian Cruise Line Holdings (NCLH) is a major player in the global cruise industry, offering a wide range of cruise experiences through its various brands. NCLH’s portfolio includes Norwegian Cruise Line, Oceania Cruises, and Regent Seven Seas Cruises. The company offers cruise voyages spanning various destinations, including the Caribbean, Europe, Alaska, and Asia. Cruises are a relatively high-cost service. * Revenue Distribution: NCLH derives revenue primarily from passenger ticket sales, which includes the cost of the cruise and associated services. Onboard and other revenues encompass sales of beverage packages, gratuities, shore excursions, and other onboard spending. * Industry Trends: The cruise industry is capital intensive, requiring significant investment in ships and operational infrastructure. While demand was severely impacted by the COVID-19 pandemic, the cruise industry has shown remarkable resilience, with strong bookings indicating a continued demand for cruise vacations. Industry consolidation, a trend that has reduced the number of operators and increased the dominance of the larger players, could change some dynamics, including market power. * Margins: NCLH experiences relatively high operating margins, especially when its ships are fully booked and its occupancy rate is high. As a result of the pandemic, NCLH’s margins have become less predictable as occupancy rates have declined and operations have been disrupted. However, these margins are likely to recover as the business stabilizes. * Competitive Landscape: The cruise industry is moderately competitive with few very large players such as NCLH, Carnival and Royal Caribbean as well as a number of smaller operators. Although product differentiation (different itineraries, entertainment, etc) is possible, commoditization is an ever present threat. Companies compete on price, location and itinerary, brand, and the overall passenger experience. * What Makes the Company Different: NCLH distinguishes itself by focusing on high-quality cruises and a flexible onboard experience that emphasizes freestyle options. They are also making strong moves toward fuel efficiency and emission-reduction. These moves can provide for a more attractive offering for the company.

Moat Assessment (2/5): NCLH has what would be considered a “narrow moat”. The barriers to entry in the cruise industry are somewhat high, requiring enormous capital outlays to acquire cruise ships, build terminal facilities and create marketing and sales programs. The large established players also benefit from economies of scale, having the opportunity to increase efficiency while cutting costs. This scale, along with a history of performance, creates some switching costs for investors, but there is little to give the company true pricing power and customer lock-in. The main thing that a cruise line does is manage logistics, and it does not directly own the assets or services needed to provide its product. A new entrant could partner with the companies that provide those resources and use a business model that is more attractive to customers. Cruise line brands are mostly interchangeable, which is to say that there is not as strong of a brand moat as some other industries. All of this translates to a less defensible market position that does not have many sources of differentiation. While NCLH has the potential to generate attractive returns on capital, they can not be relied upon to be maintained for longer periods.

Risks that could harm the moat and the business’ resilience: * Economic Downturns: The cruise industry is highly cyclical and vulnerable to economic downturns. Consumers reduce their discretionary spending during economic recessions, greatly reducing demand for cruises. This risk was painfully highlighted during the 2008 financial crisis and the covid pandemic. * Geopolitical Events and Global Pandemics: Geopolitical instability, terrorism, and epidemics/pandemics like COVID-19 can cause a big drop in demand and limit the operational capabilities of the company (ex: ship restrictions, port shutdowns, etc). Any large unforeseen global disruption can have major negative impact on both demand and operations. * High Fixed Costs: The large expenses incurred from acquiring and maintaining the cruise fleet makes it difficult to quickly reduce operating costs in times of lower demand. This high operational leverage can lead to large losses and negative earnings during downswings. * Intense Competition: The cruise industry is a competitive sector with many smaller players trying to grab share from larger players. This can cause fluctuations in demand and pricing, which will affect both revenue and margins. NCLH competes with other cruise providers on price, itineraries, and onboard experience. Competitors can offer similar itineraries or better cruises at lower cost. * Cost Inflation: High fuel prices or a rise in commodity costs for food or other materials that are utilized in operations can raise the operating costs and reduce profitability. Rising costs of labor are also a threat that the cruise line is facing. * Fuel Price Volatility: NCLH is heavily reliant on fuel for its operations, causing dramatic shifts in costs as fuel prices rise and fall. The uncertainty around fuel supply also poses a risk. * High Debt Burden: NCLH is carrying a very heavy debt load due to borrowing heavily to stay solvent during the pandemic. Servicing debt, especially in an environment of increasing interest rates, will have a large drag on profitability.

Financial Analysis

  • Revenues: NCLH reported total revenue of $1.9 billion for the three months ended in March 31, 2024, compared to $1.4 billion in the same period in 2023. The increase in revenue is driven mainly by increased passenger ticket sales and onboard spending.
  • Expenses: Total operating expenses amounted to $1.9 billion for the quarter ending March 31, 2024, compared to $1.4 billion during the same quarter in 2023. This was mainly due to an increase in fuel and operating expenses.
  • Profitability: NCLH’s operating income was $16 million for the quarter ended March 31, 2024, compared to a loss of $158 million during the same period in 2023. The swing to profitability indicates a strong recovery for the cruise line. * Return on Invested Capital (ROIC): Over the last few years the ROIC has fluctuated considerably with the effects of the pandemic. ROIC is still not a consistent part of the company, and needs to be assessed further in coming quarters.
  • Net Income: NCLH’s net income was $70 million for the quarter ended March 31, 2024 compared to a loss of $207 million for the same period in 2023. * Cash Flow: Net cash provided by operating activities was $117 million for the three months ended March 31, 2024. The amount of cash on hand has steadily decreased over the past few years, and this means that further scrutiny of their cash flow position is required.
  • Balance Sheet: NCLH’s balance sheet is severely strained and the company is heavily burdened by a significant amount of debt and liabilities. A large portion of their assets are tied to property, plant, and equipment, which are fairly illiquid.
    • Liquidity: Total cash and cash equivalents were at $1.3 billion as of March 31, 2024. While this seems acceptable, the company’s high debt burdens make this somewhat concerning.
    • Debt: NCLH has significant debt obligations. Total debt was at $12.9 billion and the company’s debt-to-equity ratio is very high, which means there is a higher risk of bankruptcy in hard economic times. There is not much wiggle room in that debt.

Recent concerns/Controversies:

  • Debt burden: NCLH has a massive amount of debt due to borrowing large amounts to keep its operations afloat during the pandemic. Servicing this debt has become a major issue that is limiting profitability. * Fuel Cost Inflation: As oil prices are high and have been consistently increasing, a large cost burden has been placed on airline companies such as NCLH.
  • Capacity and Recovery: While demand is coming back, capacity is still below pre-pandemic levels. The recovery in the travel sector has been slow and still has to go through many iterations. It is uncertain when business will fully recover.
  • Credit Rating: Moody’s and Standard & Poor’s both have given ratings to the company near or at the bottom of investment grade which has made borrowing more expensive.

Management’s View on the future: Management recognizes the current headwinds and is trying to make a more efficient business to increase profitability. They are optimistic that the business can return to strong growth in coming years, and they are also heavily focusing on sustainability in order to make the business more cost effective. They aim to lower interest rates with a better debt profile and focus more on higher yielding customers. They have many ships coming online in the next few years, that are more efficient and will attract different customers.

Understandability (3/5): The core business model is easily understandable, with customers paying for a cruise experience that includes transport, food, and accommodation. However, the business becomes more complex when dealing with the financials, operating costs, and the financial leverage they take to operate. The nature of how they gain market power is a little less obvious for those who do not know about economic moats. The industry’s cyclicality also adds a layer of complexity to the business. For these reasons, this business can be considered to be a 3.

Balance Sheet Health (1/5): NCLH’s balance sheet is extremely unhealthy. The level of debt burden on the company is high. The company has very little free cash flow available to its investors. NCLH has a lot of intangible assets, goodwill and property, plant, and equipment, all of which aren’t very liquid in times of trouble. They have a low current ratio, which means that they may have difficulty meeting short term obligations. For these reasons, NCLH gets a balance sheet health rating of 1.