Last week, I wrote that Hawaiian Holdings (HA), the parent of Hawaiian Airlines, has 100% upside in 2013. The company held its annual investor day yesterday in New York, and so I wanted to provide some additional thoughts based on yesterday's meeting (and other recent news). The bottom line, however, remains intact. I expect Hawaiian to put together a strong 2013, which will lead to significant gains in the stock. By the end of 2013, we will more likely than not see Hawaiian in the double digits (up from Monday's close at $6.19), with upside at least as far as $12. The following are the most important takeaways, in my opinion:
1) Growth will moderate in 2H13: Hawaiian has been growing at an astounding pace over the past few years, particularly with new international routes. Since late 2010, the company has added Tokyo, Osaka, Fukuoka, and Sapporo (Japan); Seoul, South Korea; New York, NY; and Brisbane, Australia to its route network. Hawaiian also announced back in July that it will begin serving Auckland, New Zealand in March, 2013. Most recently, Hawaiian announced on Monday that it will add Taipei, Taiwan to its route network in July, 2013. Hawaiian has also increased capacity (albeit more modestly) on its routes to the West Coast and within Hawaii in the past year. This growth has been accomplished without sacrificing margins.
That said, margins could be higher than they have been in 2012. There are inevitably start-up costs associated with beginning new routes, and it usually takes time for demand to spool up. Year over year capacity growth will remain rapid in the first half at 25%, but will become much more modest at 13% in the second half. Most of the additional capacity in 2H13 is due to growth in new international markets: the addition of Auckland and Taipei, and the full-year effects of the recently launched Sapporo and Brisbane services. In each of those markets, Hawaiian is beginning with service 3x weekly, which should make it easier to fill seats on a year-round basis, compared to other recent launches (e.g. Fukuoka and New York in 2012), where Hawaiian began with daily service from day 1. The slower growth rate in 2H12 should boost margins and increase 2H EPS anywhere from 50%-100% year-over-year.
While I think the second half will show the strongest EPS growth, Q2 could also surprise to the upside. The company will have some year over year cost tailwinds (Hawaiian's Q212 costs were increased by starting two new routes and taking delivery of three new aircraft in the period). More importantly, the network planning team seems to be taking a more proactive approach to shifting capacity based on seasonality. In Q213, there will be capacity cuts in some US markets (Las Vegas, San Jose) that will be reallocated to Australia which performs better seasonally in April and May.
2) Partnerships Will Bear Fruit in 2013: Hawaiian Airlines began its first significant mainland U.S. codesharing initiatives this year. (As management has pointed out, the company has decades of experience in interline and codeshare arrangements within the Hawaiian islands.) In late May, Hawaiian announced a codeshare agreement with JetBlue (JBLU) that allows travelers from numerous East Coast cities to connect to Hawaiian Airlines, primarily via JetBlue's hub at JFK Airport. Since the codeshare was announced less than a week before Hawaiian's JFK service began, the company likely did not realize the full benefits in 2012. Moreover, now that JetBlue loyalty program members know that Hawaii is an available reward destination, we may see more JetBlue frequent fliers saving up and spending their points on a Hawaiian Airlines flight. These factors should improve the performance of Hawaiian's JFK route in 2013.
Perhaps even more importantly, Hawaiian announced a new frequent flier and codeshare agreement with Virgin America last week. Virgin America has a much bigger presence on the West Coast (still Hawaiian Airlines' largest market) than JetBlue. The Virgin America partnership will allow Hawaiian's network to reach major (previously unserved) metro areas like Chicago, Dallas, Houston, and Philadelphia. Management is looking for the agreement to provide additional traffic to existing routes from Los Angeles and San Francisco to Hawaii. This should be particularly helpful because Hawaiian's recent performance has been weighed down by capacity growth in the Bay Area and Southern California (largely a result of Alaska Air Group's (ALK) growing Hawaii services). CEO Mark Dunkerley made it clear that he sees the agreement as a way to fill the existing capacity at better prices, not a prelude to further capacity expansion in those geographies.
3) Costs Continue To Drop: While management was not willing to lay out a specific target for 2013 CASM, they still clearly expect lower CASM ex-fuel in 2013. The biggest driver here is continued increases in the average stage length due to the shift towards more long-haul flying. The current trend suggests that CASM ex-fuel could be down 5% or so for FY13, with the biggest decreases occurring in the first half. The key point is that management remains confident that Hawaiian Airlines has costs equal to or lower than its U.S. competitors (principally United Airlines (UAL) from Los Angeles and San Francisco, and Alaska Airlines from a variety of West Coast cities). (Hawaiian has a significant cost advantage vis-a-vis international competitors, because most of Hawaiian's costs are dollar-dominated, and the weak dollar provides a big tailwind.) Management does not believe that any current or future competitor (e.g. Southwest Airlines (LUV)) can provide good service at a better price. While Allegiant (ALGT) can offer a cheaper ticket to Hawaii, the bare-bones nature of its offering does not appeal to most Hawaiian Airlines customers, who want a more comfortable and service-oriented airline.
In sum, 2013 continues to look like it will be a good year for Hawaiian Holdings. Fuel costs and the macroeconomic picture can obviously have a significant impact on airline results. Fortunately, they tend to move in opposite directions: fuel costs should fall in a recessionary economy. Barring drastic shifts in either of those two variables, I expect to see steady improvement throughout 2013, with each quarter showing better year-over-year EPS trends than the previous one. As a result, I continue to think Hawaiian is a strong buy.