On Tuesday afternoon, Hawaiian Holdings (NASDAQ: HA ) -- the parent of Hawaiian Airlines -- reported in-line adjusted EPS of $0.69 on revenue just shy of $600 million (up 9% year over year). The results show that Hawaiian is continuing to rebound from a confluence of factors that led to sharp profit declines in Q4 of 2012 and Q1 of 2013.
Looking forward, Hawaiian is well positioned to expand its profit margin over the next several quarters, driving solid EPS growth. Hawaiian's stock has already gained more than 50% since bottoming out in April, but the company's long-term growth prospects and significant potential for margin improvement leave plenty of room for further share price appreciation.
In recent quarters, Hawaiian has posted significant declines in unit revenue, hurting profitability. These declines were caused by a variety of factors, including a shift toward longer routes (which tend to have lower unit revenue), heavy competition on flights between the U.S. West Coast and Hawaii, unfavorable currency movements, and overcapacity for flights within Hawaii.
Revenue per available seat mile, or RASM, began to decline in Q3 2012, when it dropped 5.8%. RASM fell an even steeper 12% in Q4 2012 before pulling back to a 10.8% decline in Q1 2013 and an 8.9% decline in Q2. But RASM finally returned to growth last quarter, increasing 0.1% year over year.
This flat performance masks wild swings within the different regions Hawaiian Airlines serves. A small decline in industry capacity between the West Coast and Hawaii and solid demand drove a 10% increase in passenger revenue per available seat mile for North American long-haul routes. With industry capacity expected to continue declining for at least two more quarters, this strong performance in North America is likely to continue.
Meanwhile, changes in Hawaiian's inter-island schedule and revenue management strategy drove significant improvement in the company's short-haul business. Passenger revenue per available seat mile, or PRASM, rose an astonishing 15.9% for the Neighbor Island business.
Unfortunately, the strength in these two parts of Hawaiian's business was offset by a massive 17.7% decline in PRASM for international routes. The strengthening of the dollar compared to the currencies of Hawaiian's international markets decreased PRASM by 11% (before hedging effects). The remainder of the decline was driven by mix changes and competitive pressures in a few markets.
Ready for earnings growth
Fortunately, Hawaiian is likely to reverse some of these unit revenue declines over the next year or two. Nearly all of Hawaiian's international routes have been introduced within the last three years. As a result, many are still in the maturation process, and unit revenue will improve over time as Hawaiian improves its brand recognition and sales techniques in those markets.
Furthermore, the negative impact of currency movements will wear off over the next two or three quarters if exchange rates remain near their current levels. Lastly, competitive pressures should start to ease. Hawaiian CEO Mark Dunkerley noted that capacity from Korea is already starting to drop as Hawaiian's rivals remove unprofitable capacity that they added last year.
Meanwhile, in Japan, Delta Air Lines (NYSE: DAL ) is cutting capacity to beach markets due to the weak yen. This includes using a smaller aircraft on its Honolulu-Osaka route, where it is one of Hawaiian's two direct competitors. Delta is also trimming capacity at Narita International Airport near Tokyo, where it competes indirectly with Hawaiian's flight from Haneda Airport.
Hawaiian expects these tailwinds to permit an acceleration in unit revenue growth to between 2.5% and 5.5% for Q4. This should more than offset an expected 2%-5% increase in non-fuel unit costs, especially since fuel costs are falling.
The resulting margin growth puts Hawaiian on a path to earn EPS in a range of $0.20-$0.30 next quarter, based on the recent jet fuel price. That's much better than last year's breakeven result, and provides some upside to the average analyst estimate for Q4 EPS of $0.20. EPS should continue to improve throughout 2014.
Despite the improving outlook, Hawaiian Holdings shares fell steeply on Wednesday. The stock dropped nearly 10% before recovering to a 6% loss by midday. But I believe the company has a bright future so I am standing pat with my investment. If the stock falls any further, it will create an attractive buying opportunity for value-oriented investors.
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