Norwegian Cruise Line has followed the market’s trajectory closely. The stock is down 5.6% to $18.79 per share over the past six months while the S&P 500 has lost 1.7%. This might have investors contemplating their next move.

Is now the time to buy Norwegian Cruise Line, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Even with the cheaper entry price, we don't have much confidence in Norwegian Cruise Line. Here are three reasons why you should be careful with NCLH and a stock we'd rather own.

Why Do We Think Norwegian Cruise Line Will Underperform?

With amenities like a full go-kart race track built into its ships, Norwegian Cruise Line (NYSE: NCLH) is a premier global cruise company.

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 5.88 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. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Norwegian Cruise Line, its EPS declined by 18.7% annually over the last five years while its revenue grew by 8%. This tells us the company became less profitable on a per-share basis as it expanded.

3. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

Norwegian Cruise Line’s $13.1 billion of debt exceeds the $190.8 million of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $2.45 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Norwegian Cruise Line could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Norwegian Cruise Line can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

Norwegian Cruise Line doesn’t pass our quality test. Following the recent decline, the stock trades at 9.1× forward price-to-earnings (or $18.79 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better investments elsewhere. We’d recommend looking at a dominant Aerospace business that has perfected its M&A strategy.

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