The airline group was one of the best-performing sectors in the stock market last year, and 2014 is shaping up to be much the same. Almost every airline stock has been beating the market, and many are reaching long-term highs, including two of my favorites: Hawaiian Holdings (NASDAQ: HA ) and JetBlue Airways (NASDAQ: JBLU ) .
Hawaiian Airlines has hit a series of new all-time highs this year, and recently reached $16 for the first time ever. Meanwhile, JetBlue stock reached the $10 plateau this week -- a place it hasn't been since before the Great Recession. Despite the surges in their stock prices, I believe Hawaiian Holdings and JetBlue Airways have plenty of long-term upside left, so I'm not selling.
Profit in paradise
Hawaiian Airlines has two main profit-growth drivers that should allow the company to double its net income relative to 2013 within the next three years. The first initiative is a retooling of its international route network. International routes accounted for 28% of company revenue as of last quarter. But a few underperforming routes and unfavorable currency swings have hurt the profitability of Hawaiian's international operations.
This spring, Hawaiian has made some major changes to its international route network. In April, it dropped its new service to Taipei and reduced its flights to Seoul from daily to five times weekly. Later this month, it will end its unsuccessful daily service to Fukuoka. On the other hand, Hawaiian has been adding seats to Brisbane, one of its more successful international markets.
Dropping or reducing service on underperforming routes should quickly improve the profitability of Hawaiian's international business. The routes it is maintaining should also continue to mature and grow more profitable over time.
The second initiative that will boost Hawaiian's earnings is a focus on growing ancillary revenue. One easy source of incremental revenue is Hawaiian's new credit card deal. It will provide an extra $100 million in cash flow over its six-year term -- money that will all flow to the bottom line eventually.
For customers, the most noticeable change will be the introduction in August of "Extra Comfort" seating featuring more legroom and other perks. Each of Hawaiian's A330 aircraft will have 40 Extra Comfort seats, which will cost an extra $60-$100 one way. Given that Hawaiian's long-haul flights are generally five to 10 hours, plenty of customers will be willing to pay for this upgrade.
JetBlue ready to rise
JetBlue is using some similar strategies to improve its profit margin and thereby drive further stock price gains. Most notably, JetBlue is creating a dedicated sub-fleet of A321 aircraft to serve transcontinental routes from JFK Airport to Los Angeles and San Francisco. These planes will have a premium section with 16 lie-flat seats, an amenity JetBlue has never previously offered.
Today, JetBlue is selling these premium seats for $599-$999 one way. Long term, JetBlue's management believes that it will be able to charge even more for lie-flat seats on those routes. Either way, it's a far cry from the roughly $260 average fares it has been getting recently.
In addition to seeking revenue gains from premium seats, JetBlue is also working to reverse the recent trend of cost creep. The most important initiative there is its fleet restructuring plan. JetBlue is focusing on the A321/A321neo for the vast majority of its growth between now and 2019.
In fact, 73 of the 81 aircraft JetBlue plans to add to its fleet between 2014 and 2019 are A321s. Some of JetBlue's A321s are being configured for long-haul routes with 159 seats, including the 16-seat premium cabin. But the vast majority will have 190 seats, whereas most JetBlue planes today have 100-150 seats.
The 190-seat A321 will offer a double-digit reduction in unit costs compared to JetBlue's fleet average. The A321neo will be even cheaper to operate, due to its fuel-saving engine technology. The growth of JetBlue's A321 fleet -- along with other smaller cost-saving initiatives -- will sharply reduce (or reverse) JetBlue's cost creep in the next few years, allowing future revenue gains to drop to the bottom line.
Foolish final thoughts
Hawaiian Airlines and JetBlue Airways are both growing faster than the airline industry average. This growth has created plenty of challenges, causing both carriers to lag peers in terms of margin performance.
But both companies are now addressing their margin shortcomings. Hawaiian Airlines is cutting unprofitable international routes and redeploying that capacity to better-performing areas, while also working to grow ancillary revenue. JetBlue is adding a premium lie-flat seats on its transcontinental flights to boost revenue while introducing more efficient A321 aircraft to its fleet to keep unit costs down.
These initiatives are likely to move Hawaiian Airlines and JetBlue at least to the middle of the airline pack in terms of margins. That's far better than they have been doing recently. The resulting profit growth should drive market-beating stock performance over the next five years, even though both are already at long-term highs.
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