Hawaiian Holdings Earnings: Margin Pressure Continues

Adam Levine-Weinberg, The Motley Fool

Over the past year or so, Hawaiian Holdings' (NASDAQ: HA) profit margin has plunged as the airline has faced a surge in competition on West Coast-Hawaii routes, a downturn in demand for inter-island flights, and rising fuel and labor costs. For 2018 as a whole, Hawaiian's adjusted pre-tax margin fell to 12.6%, down 4.4 percentage points year over year.

Some of these pressures are worsening, as Southwest Airlines (NYSE: LUV) recently began selling tickets for flights to and within Hawaii. As a result, Hawaiian Airlines' profitability declined again last quarter -- and the outlook for the second quarter looks no better.

Hawaiian Holdings results: The raw numbers

Metric

Q1 2019

Q1 2018

Year-Over-Year Change

Revenue

$657 million

$665 million

(1.3%)

Total unit revenue

13.54 cents

14.06 cents

(3.7%)

Adjusted cost per available seat mile excluding fuel

9.87 cents

9.73 cents

1.4%

Adjusted net income

$32.6 million

$55.8 million

(41.7%)

Adjusted pre-tax margin

6.7%

11%

N/A

Adjusted EPS

$0.67

$1.09

(39%)

Data source: Hawaiian Holdings Q1 earnings release. Chart by author.

What happened with Hawaiian Holdings this quarter?

During the first quarter, Hawaiian Airlines completed its fleet transition from the Boeing 767 to the state-of-the-art Airbus A321neo. In addition to having lower unit costs than the 767, the A321neo is about 25% smaller, allowing the carrier to enter new markets that couldn't support a larger aircraft. The fleet transition is also enabling Hawaiian to cut capacity on underperforming routes while adding smaller increments of capacity to high-performing West Coast-Hawaii routes.

Despite this tailwind, lingering overcapacity between the West Coast and Hawaii caused a mid-single-digit unit revenue decline in the mainland-Hawaii market last quarter. Hawaiian reported a similar unit revenue decline in the inter-island market, driven by weak demand for travel to Hawaii's Big Island.

Another big highlight of the quarter was Southwest Airlines' long-anticipated launch of Hawaii flights. Southwest began flying once a day between Oakland and Honolulu in mid-March. By late May, it will offer six daily round trips from Oakland and San Jose on the mainland to two destinations in Hawaii, along with 16 daily inter-island flights -- four daily round trips each on the Honolulu-Kahului and Honolulu-Kona routes. More routes are planned for the future, but the grounding of the 737 MAX has put Southwest's expansion plans on hold for now.

After the end of the quarter, Hawaiian Airlines began two new routes. Hawaiian complemented its existing Sacramento-Honolulu route with a daily round trip between Sacramento and Kahului. It also added Boston as its 13th destination in the continental U.S., with service five times a week to Honolulu. Both new routes continue the carrier's effort to diversify its route network.

What management had to say

Hawaiian Airlines CEO Peter Ingram acknowledged that the company's results haven't been fully satisfactory recently. However, he noted that the carrier is making progress on many strategic initiatives that should improve its long-term competitiveness:

We made important progress against our 2019 priorities in the first quarter, advancing a host of initiatives that will bring lasting value to our guests, our team, and our shareholders. Executing the winning formula we have crafted in the course of 90 years of serving Hawaii with the best mix of service, products, and aircraft positions us well to continue to succeed in the face of an evolving competitive environment. We look forward to the rest of 2019 and demonstrating, yet again, that Hawaiian is the carrier of choice to Hawaii.

Looking forward

Notwithstanding management's apparent optimism, Hawaiian Airlines' forecast for the second quarter implies further margin deterioration and another earnings decline.

A Hawaiian Airlines plane flying over the ocean, with mountains in the background

Hawaiian Airlines' pre-tax margin still hasn't stabilized. Image source: Hawaiian Airlines.

Revenue per available seat mile (RASM) is on track to decline 2% to 5% this quarter, roughly in line with Hawaiian's first-quarter performance. Meanwhile, costs are likely to increase modestly. Based on the midpoint of the company's guidance range, nonfuel unit costs would rise 1% and fuel prices would increase about 6% year over year, offset by a 4% fuel-efficiency improvement. In all, Hawaiian Airlines' guidance implies that its pre-tax margin will fall to around 9% or 10% in the second quarter, compared with 13.7% a year ago.

It's possible that RASM trends will improve during the summer peak season. That said, with Southwest likely to further ramp up its Hawaii flight schedule this fall, a potential return to unit revenue growth in the third quarter could prove ephemeral. A more durable recovery may depend on self-help efforts like implementation of a basic economy fare option (planned for late 2019), winning approval for a joint venture with JAL for the Japan-Hawaii travel market, and possible moves to reallocate capacity away from some Southwest Airlines markets.

As management has noted, Hawaiian Airlines' identity as the only major Hawaii-based airline, its cost structure, and its service quality represent key competitive advantages. Even so, investors should buckle up for what could be a wild ride over the next few quarters.

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Adam Levine-Weinberg owns shares of Hawaiian Holdings and Southwest Airlines. The Motley Fool owns shares of and recommends Southwest Airlines. The Motley Fool recommends Hawaiian Holdings. The Motley Fool has a disclosure policy.