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Hawaiian Holdings, Inc. (NASDAQ:HA)

Deutsche Bank 2012 Aviation and Transportation Conference

September 6, 2012 3:55 PM ET

Executives

Scott Topping – EVP, CFO and Treasurer

Unidentified Analyst

Okay, thank you. All right, for our next presentation this afternoon, we’re very pleased to have Scott Topping, Executive Vice President, Chief Financial Officer and Treasurer of Hawaiian Holdings. Scott was appointed CFO of Hawaiian in 2011. Prior to becoming CFO, Scott spent six years at South West Airlines in various senior roles, most recently as Vice President and Treasurer.

And so now, to provide us with an update on the Hawaiian story, Scott Topping.

Scott Topping

Thank you Mike and thank you everybody for coming out and spending some time with us today. Before I get started, I’d like to introduce Susan Donofrio, our Senior Director of Investor Relations. I know many of you know Susan already with her years in the industry, we’re happy to have her here.

What I’d like to do today is leave you with some thoughts around how Hawaiian Airlines is different. We are certainly charting our own course. We have different business model and we’re a much different airline than we were just a few years ago. And these are very, very positive things.

To see this, I’m going to organize my talk around the strategy and network, we’ll look at growth opportunities, we’ll take a look at financial performance and then we’ll look at how we manage our balance sheet which is pretty critical when you’re growing at 20% to 30% clip.

So, let’s start with the strategy. Our business model is simple as many successful models are. We’re not though a network carrier and we’re not a point-to-point carrier. Based on where we’re located, we are a destination carrier. And our franchise, you could put it simply as that we sell Hawaii experiences. We bring people to Hawaii.

On top of that, we’re in the midst of implementing a growth strategy and diversifying our business. We’re roughly two times the size we were five years ago as measured by revenue.

In the strategy, on top of the business model has several advantages. And I believe these are sustainable competitive advantages, just being focused on Hawaii doing one thing that’s important. We’re growing into regions where the demand for the Hawaii Vacation is growing and we’ll look at some of those numbers in a bit. As the leisure carrier, we’re less sensitive to economic downturns, and we’re enjoying economies of scale as we grow.

Let’s take a quick look at our fleet. We have narrow body and wide body aircrafts totaling 43 today. We operate 18 Boeing 717s in our inter-island network with about 123 seats. And it’s the perfect airplane for short-haul, high-frequency flying. The airplane is durable, it has good economics. And it should get us through the decade, if not further.

We’re transitioning our wide body fleet by retiring 767s and adding Airbus A330s to our longer haul services. Currently we have 15 767s worth about 264 seats and nine A330s with 294 seats. The 767 is a fine airplane, but the A330 gives us about 30 more seats, a bit more range and a better cargo capabilities. In 2015, our transition will look like this, we’ll have 22 A330s, and nine 767s.

So, let’s take a look at the network broadly. I know you can’t read this. But the point here is that we have a lot of reach. We’re on the East Coast of the US, we were in the Far East. Also note how everything connects to Hawaii, that’s the point, we’re a destination carrier, and we’re converging in the middle.

So, let’s break the network down. First, we have the neighbor island it’s about quarter of our revenues. It’s a unique, very high frequency, very short-haul market. We have a very strong competitive position with over 85% seat-share. Several routs in this network or among (inaudible) to the US, it surprised me to learn when I came to Hawaii and that we operate a 170 round-trips in the network each day. And as an example, Honolulu to Maui, we operate 32 round-trips per day, very busy.

And the unique part about this is that we carry everyday life. If you go to our inter-island terminal, you will see the soccer teams, with parent’s and toe, boarding the aircraft, you will see people coming to Honolulu for medical services, you’ll see the ATM repair man throw his tools on board off to another island to fix the ATM machine. This is a lot of our business and this makes it very stable and it’s relatively in elastic demand.

North America represents just under half of our business. We have outstanding brand recognition. We have 11 gateways with the addition of JFK back in June. And we do see growth opportunities in North America. Canada for instance more on the East Coast might be of interest as well.

The third segment is international, and this is approaching 30% of our business. It is the engine of growth and diversification which is an important part of our strategy. In the coming – fourth quarter, we will add two cities, Sapporo and Japan, which will be our fourth city in Japan. Brisbane, Australia, our second city in Australia and Auckland, New Zealand, which will be our first to that country.

So, I’d like to show you how this international growth has kind of reshaped the airline. On the left, this pie is in 2007, you can see, in the blue, North America is almost 70% of our revenue. Five years later, North America represents under half but 47%. You can see Neighbor Island is fairly stable. And international makes up the difference at 26, I’m sorry, 27%. So, our strategy has reshaped the airline. We’re bigger and we’re more diverse.

So, let’s focus on some of the growth opportunities. Now, we’ve taken some liberties with this scale on this map. So, just to orient you the purple dots are major markets of that Hawaiian does not serve today. All of these would make some sense to us. The biggest dot is the population of more than 20 million. The next biggest is 10 million to 20 million, the third largest is 5 million to 10 million and so on. So, it gives you a sense of where they are and how big these markets are.

The lines connected with, following the blue lines connecting cities are current service or service that we’ve already announced. And since you can’t name – since you can’t see these, let me name just a few on the left, we have Beijing, Shanghai, Hong Kong, on the right, we have Toronto, Boston and Philly just to name several.

So, let’s take a deeper dive and look at the demand growth for the Hawaii vacation in a few regions. Australia and New Zealand, being the first one and what I’m showing here is visitor arrivals annually to Hawaii. We are looking at a compound annual growth rate in the first chart of 25% in Australia and New Zealand. Korea is the next example, this one is 2008 to 2011, you can see a 38%, its smaller base well it’s a pretty rapid growth rate.

The Greater China would be on interest. You can see that growing at 32%, including Mainland China, Hong Kong and Taiwan. And today we are learning quite a bit about China with an agreement with Air China, we’re connecting passengers oversold South Korea. This has given us an opportunity to book on Air China, they can book on us. We’re learning quite a bit about booking patterns and price points for leisure travelers to China, we’re bringing a lot of tour groups through. This is exciting for us, it’s a first step into that market which should be fairly important for us one day.

Canada, is also on our radar with a growth rate, of visitors to Hawaii of 17%. So, summarizing this section, we have high demand growth, we have many opportunities. And it all fits nicely within our business model. So, I’d like to shift gears now to financial results.

And I’ll dwell a little bit more here just on long-term what we’ve done with the strategy over a longer period of time. I’m not going to take you through the details of our recent financials because we do that every quarter.

Let’s look at ROIC. So, you can see here, some pretty nice numbers, now these are pre-tax. But for the past five years, the average pre-tax ROIC is 13.2%. Our trailing 12 months is running at 16.6%, and it’s interesting that 2009 is our best year here, given where the economy was, that’s a bit surprising. We were a bit surprised at just how resilient the Hawaii vacation was in 2009. We can’t guarantee that would be something that’s repeated.

But I think a couple of factors went into that that might be repeated in a downturn. One, hotel discounting was prevalent, making the total cost of the Hawaii vacation less. Airfare is going to be about four to a third of the total cost of the Hawaii vacation. And secondly as you remember, energy prices bottomed I believe in the first quarter of 2009 and started gradually going higher, so we enjoy a period with lower energy prices. We came out with a very good year.

The next chart is one of my favorite slides. It fought profitability against growth. So, what you have here on the horizontal axis is ASM growth, and this is over five-year period as well. The vertical axis is cumulative EBITDA margin. So, you can see, being in the upper right quadrant there is good place to be, we lead the way. And EBITDA margin, you can see the bigger carriers to the left with quite a dispersion of EBITDA performance but all kind of centered on the same type of ASM contraction which is no surprise.

But the point here again is that we’re different. We are different model. We have different results. And in our performance in the near-term has also been good. Again, I’m not going to take you through this one. This is our first half of 2012, sufficed to say that we went from about a break-even operating income in the first half of 2011, which was a somewhat tough year to make a 40 million in the first half of 2012.

So, let’s take a look at some cost trends this stacks up carriers. Happily we’re on the far left with a minus 2% cost reduction. This is trailing 12 months at 2Q. A nice performance, again we have economies of scale that we’re beginning to enjoy as we grow. A 2% reduction was achieved in spite a concentration of start-up costs. Earlier in the year we had heavy start-up costs. We had a training bubble related to new city openings. They all collected in the first and the second quarter.

And growth in the second half of the year should continue to help drive our CASM x-fuel lower. So, all in all, I think the strategy is bearing fruit and we’ve been able to growth profitably over the long term.

So, let’s now take a look at the balance sheet. We’re very mindful of our balance sheet as we continue to execute our growth plans. We feel a buffer is important as we enter into new markets, buy new airplanes and take risks of our growth strategy. And to guard against the prizes, we keep a high level of liquidity. Just to orient you here, the bars would be our cash in short-term investments, plus the revolver capacity which is running at about 65 million currently, that goes against the left-hand scale.

The red line is that total liquidity against trailing 12-month revenues. And you could see that’s bouncing around, kind of in the 25% area with 20% being kind of the investment grade standard by our friends at the rating agencies. We think this is very appropriate given where we are in our developments and given our risk profile.

Now, let’s take a look at our debt. Here is just a summary of our financings. At the end of the quarter, we have again the revolving credit facility I mentioned, its term is – it’s due in 2014. We have convertible notes, 5% coupon due in 2016. Our aircraft debt consists of a financing 15 717s, we did this last year. These were leased and we would finance them with debt to get economic benefit. That’s 178 million.

We have a facility on three 767s, that’s our only floating rate debt today. That’s due at the end of next year and it’s our first bullet maturity of any size, it should amortize down into the $50 million range. And then you’ll see four bank debt facilities on a A330s, the last four items on the list. Those are all fixed rate as well and at very attractive terms.

So, let’s see how this all translates to leverage. This is a little busy, so I draw your attention to the line. This is how our lease adjusted debt to total capital. You can see that historically. We also have a forward look at this and it’s under two scenarios. They’re around a base, so they just give you a range of possibilities that I think would be realistic. We have an upside case and a downside case. The upper line is the downside case. And we reduce revenues by 3% in 2013, 4% in 2014 and 5% in 2015. And at the same time, we run fuel prices higher by 4%, in each of the first two years and 3% in 2015, that’s just a sensitivity that we run.

The bars just show how many deliveries of A330s are coming each year. And you can see there are five in each of the next two years. So, the point of all this is to say that although our aircraft related CapEx is going higher, it’s a fair amount higher actually than 2012. Our leverage kind of continues its trend lower and at worst it kind of gets flat. So, that really hasn’t taken hold with a lot of the investors we talked to in our one-on-one, so we’re trying to bring a sense of what’s really going on with our balance sheet here and this is not by accident.

So, let’s look at our financing plans as we continue to transition into the A330s. First, is to quick look at the history on the left hand side. Since 2010, that’s when we started bringing in the A330s, we’ve taken nine of those to date. And we took four of those this year. You can see a mix of leases and own their craft, four leases, four with bank debt and one say on lease back.

For next year, we have covered three of our five deliveries. We have two sale on lease-backs lined up and one covered with bank debt. We are in discussions with the number of parties on what to do with the remaining two aircrafts. The good news is that we have – we’re term sheets than we have airplanes, so we’re taking our time here and trying to make sure we choose the best financing for Hawaiian airlines and we should have some progress to report in the near future on those.

My last topic, and it relates to the balance sheet is our fuel hedging program. You can see our profile here, so in the chart, what this is telling us is that, we will be somewhere between 60% and 80% hedged as we move into a period. We’ve been more on the lower end of that. So, as we enter into the current quarter, we’ll have a 60% position. And then we scale it down as you see here. We’ll go out as far as 24 months. We could be 12 months. And right now we’re running kind of in the 18-month range, so just kind of right down the middle of this shape.

We feel that, from a philosophical standpoint, hedging is the right thing for Hawaiian airlines to do at this time. There are plenty of things that happened in our industry that we can’t plan for. Risks, like terrorism risks, like SARS, all these things so we’re trying to execute a growth plan. We want to control our enterprise risk and hedging falls right in line with things such as capital structure, things we can manage. So, we feel it’s the right thing to do.

Our program is fairly simple. We have call options for most of the hedge. We do use a few callers. We’re selective about that because we understand that putting callers in, put floors in and it creates risk of another kind when things go south.

And we’re, very disciplined about how we layer in these hedges. We may vary just a little bit around the edges if we see what we think are good opportunities. For instance, if something happens in Europe, you get a headline. Energy prices fall by $5 you watch that a little bit, they stay down. The key there is, if it falls 12 months to 18 months out because of something that affects right now that maybe a good time to accelerate a lower of our hedging.

But we wouldn’t do it to a degree that it was very material. We might accelerate next week’s hedging into this week. So, we try to be a bit smart about it, but for the most part it’s a very systematic approach that we take. And you can see here, our positions in place at the last quarter reporting period.

So, to wind things down, I’d like to summarize some key points to the Hawaiian value proposition. And I’d organize it under kind of two categories. The first one being, we are different. And this has its advantages. We are focused on one thing. We are different than we were just a few years ago, we’re bigger, we’re stronger and we’re more diversified and we’re a leisure carrier, which gives us some resistance to recession, certainly not recession proof but there is evidence that we are less exposed to economic cycles.

The second point is around our strategy. We are growing where the growth is. And there are many opportunities that we could continue to pursue. And we’re one of the few airlines that, has been able to grow profitably.

And lastly we are, very disciplined in managing our balance sheet. And we think that is really a key thing for us as we continue to take measured risk and move into new markets.

So, with that I would open up to questions.

Question-and-Answer Session

Unidentified Analyst

Scott, if I could ask just a couple. One, thanks for providing the ROIC data, so it’s good to see that. More and more carriers are providing that and are starting to live by it, which is good. When your numbers are a little bit higher, I’m curious about what your target is and maybe it’s more of a range, sort of the number that you want to beat, what that hurdle is. And maybe how that compares your weighted average cost to capital, it can be rough numbers as well since I know some of the…?

Scott Topping

Sure, sure. We don’t have an official target that we’ve announced. I think if I were to just throw something out there, it would be beyond 15%. But again that’s not official. You mentioned, I think the key point how – what kind of spread do you have on your weighted average cost to capital. Our marginal cost of capital which I think is the right measure is in the 6% area. So, we’re making a very nice spread.

Unidentified Analyst

Okay. And then just, my second question, you recently provided in Investor Update. It looked like that the unit revenue came in a little bit lighter than what you had forecasted back at the end of the July on your June quarter conference call. We also saw that your unit costs also came in a bit better, so maybe a bit of a loss, now it’s standing maybe a slighter higher fuel price. What, what’s out there, maybe putting a little bit of pressure on the prism, is it mix, is it competition, we’ve seen some new carriers move into the Hawaiian market? Is it some of the ramp up of additional capacity, either into markets like Australia or new service into some of the Japanese destinations having some impact?

Scott Topping

Yeah, I’d break it down a bit. In North America, given the capacity increases that are out there and these are just in pockets. Loads and fares have held up relatively well. But nonetheless, the environment has become a tad bit more difficult to continue getting increased yields.

So we find ourselves, especially when you’re laid in the booking period, it comes back to that entire cost of the Hawaii vacation, we have occupancy rates and hotels very high, nudging up prices for hotels again later in the booking period. And that does have an influence. So, then we find ourselves kind of dropping down to the next fair bucket. So, we’re hitting good volumes, we’re just trading volume for fair. And again, this is just in a just a small portion of our network but enough to kind of move the needle in North America.

If you look at international, it’s a little bit more load factor. Demand is strong internationally pretty much across the board. But we’ve done some of this to ourselves, we’ve known we were doing it but we have some increases in our own capacity in turn, we went from four times to daily service just back in July. Fukuoka, which we just opened in April, is developing and it’s in line with the plan. But we’re kind of growing into some of these services. Sydney is another one back in December, we went to daily service. So, that’s kind of the feature on the international side, that’s just a bit softer on the load side.

Unidentified Analyst

Great, thank you.

Scott Topping

Sure. Any others?

Unidentified Analyst

Yep, just two quick questions. And the first one is probably most important. If you guys are hiring at Hawaii, because I would love to come out to Hawaii and actually work with you guys.

Scott Topping

Yeah.

Unidentified Analyst

(Inaudible). I’ll talk to you guys after some time, if that’s okay. The second one is you had mentioned growth opportunities within with America primarily in Canada and the East Coast, and East Coast you put less of an emphasis on. I was wondering whether or not you guys have any current plans that you are under discussion and then timing on that?

Scott Topping

Not surprisingly, the answer is no. No current plans that we can discuss. I would say that we are interested in the East Coast. We have an opportunity set, many, many opportunities. And as we look at those, obviously the dynamics of the marketplace, political, competitive and a lot of factors come into play when we’re choosing new markets. And we’ve laid three in front of us now that we’re going to tackle those. We look at the next one, it’s going to be kind of a function of timing, because I think as many of you know in this industry that you can pick the right market. But if you pick it at the wrong time, you can get your head handed to you. So, it’s kind of hard to see from where we are, what our next choice is going to be. But I think you can rest assure that we’ll would have done our homework and we’ll make a good selection.

Unidentified Analyst

Okay. And then, on – just one more final one. On Asia-Pacific, you made a comment that it’s expected to grow 6.6% from 11% to 2020, versus North America which is 3.4%. Is that primarily from destination travelers or is that just growing wealth like for instance in Vietnam, that’s local traffic?

Scott Topping

Yeah, I think it is more of a broad statistic just on air-travel in general, it was some Airbus data that we had, yeah. Okay, looks like, I’m at zero.

Unidentified Analyst

Okay, very good. Well, thank you Scott.

Scott Topping

Thank you.

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