Carnival (CCL -0.66%) has taken investors on a nauseating ride this week. Shares of the cruise operator plunged following the release of its second-quarter results earlier in the week.
However, they've since recovered those losses and then some on optimism that demand for cruising remains strong. With that rebound, they've more than doubled so far this year.
I recently cashed in on some of that recovery by selling my shares of Carnival with the view they would never fully recover to their pre-pandemic peak. While I might have given up a little too early, I don't regret selling the cruise stock. I see concerning headwinds that could cause shares to remain very volatile and potentially plunge again.
Demand headwinds could be on the horizon
Cruising has nearly fully recovered from the pandemic. The industry expects to welcome 31.5 million passengers this year, which would exceed 2019's level. Meanwhile, industry revenue is on track to nearly double from last year to $21.1 billion, putting it within reach of 2019's $23.4 billion haul.
Carnival is certainly benefiting from this rebound. The company reported $6.5 billion in revenue for the second quarter, a record for that period. It also reported positive operating income for the first time since it resumed cruise operations and is generating free cash flow.
Meanwhile, demand for future cruises remained robust. The company saw an acceleration in demand in the period. Total customer deposits for future cruises reached an all-time high of $7.2 billion, eclipsing the previous quarterly record by $1 billion and up 26% from the prior quarter.
However, while demand is strong right now, several economic indicators suggest a recession could be right around the corner. Consumers have historically pulled back on discretionary spending during a downturn due to concerns they might lose their jobs.
That could impact future cruise demand as consumers hold off on booking their next cruises. A steep recession could have a meaningful impact on Carnival's revenue and cash flow, which would likely cause its stock price to plunge.
A massive anchor holding it back
One of the main reasons I sold my Carnival shares stems from my concerns about its ability to address the boatload of debt it took on in the pandemic's aftermath. The cruise ship operator burned through cash to continue to operate and also to fund its capital program.
On a more positive note, Carnival has shifted from burning through cash to generating positive free cash flow. That's allowing it to start chipping away at its debt. It repaid $1.8 billion of debt principal during the second quarter, including the remaining $200 million on its revolving credit facility. However, it still has nearly $34 billion of debt outstanding, roughly a third of which matures through 2025.
It needs to generate positive free cash flow to continue repaying debt while also funding its sizable capital program. The company plans to invest $11.7 billion through 2026 on capital projects, including $5.1 billion on contracted newbuilds through 2025.
Carnival believes it will have the cash flow and liquidity to navigate its debt and capital spending without issuing more stock and further diluting investors. However, that assumes continued strong demand and improving earnings. A deep recession would likely weigh on future bookings and cash flow, impacting its ability to continue repaying debt.
Don't expect smooth sailing ahead
Demand for cruising has more than recovered from the pandemic, which is enabling Carnival to start chipping away at the debt it took on to stay afloat during that period. However, the company could still face some rough seas ahead if the economy experiences another downturn, which might impact its deleveraging plan.
Because of that, the stock could continue to be volatile. That's a risk investors must consider before buying the stock following its big rally this year.
