For several decades, Hawaiian Holdings (NASDAQ:HA) has flown between the U.S. West Coast and Hawaii with an all-wide-body fleet. Wide-body aircraft have high seating capacities, which has helped Hawaiian Holdings keep its unit costs competitive. But rivals like Alaska Air (NYSE:ALK) have gained share by using long-range narrow-bodies that are more suitable for markets with less demand.
For that reason, Hawaiian Holdings has ordered a fleet of Airbus A321neo narrow-body planes, which will arrive beginning in 2017. These highly fuel-efficient narrow-bodies will give Hawaiian a much more flexible fleet. This will enhance its competitiveness on West Coast-Hawaii routes, leading to higher long-term profit margins.
Alaska Air fills a void
For almost a decade beginning around 2000, Hawaiian Holdings maintained a rivalry with Aloha Airlines on routes between Hawaii and the U.S. mainland. But Aloha folded in 2008 due to the combination of soaring fuel prices and a slowing economy. This left Hawaiian in a very strong position.
However, it's rare that a vacuum lasts for long in the airline industry. Sure enough, Alaska Air began a rapid expansion in Hawaii following the demise of Aloha. In 2009, just 7% of Alaska's system capacity was devoted to Hawaii service. By 2012, flights to Hawaii represented roughly 20% of Alaska's capacity. That puts Alaska roughly on par with Hawaiian Airlines in terms of West Coast-Hawaii capacity.
Much of Alaska's new service connected cities in California to secondary destinations in Hawaii -- not Honolulu. Alaska is able to make these flights work because it has a relatively good cost structure and flies 737-800s on most Hawaii routes. These planes have been configured with 157 seats, although Alaska has recently added a row to increase capacity to 163 seats.
This is a good size to match supply to demand on many of the routes to the outlying Hawaiian islands. Even so, Alaska only operates three to four flights per week on some routes to Kona and Lihu'e.
Hawaiian Holdings' dilemma
Unlike Alaska Air, the vast majority of Hawaiian Airlines' flights from the West Coast go to Honolulu. (Hawaiian Airlines also operates a small hub in Maui with flights to a few West Coast cities, and this summer it began offering seasonal service from Los Angeles and Oakland to Kona and Lihu'e.)
Indeed, one of the big reasons why Hawaiian Airlines did not move quickly to backfill all of the routes previously served by Aloha and ATA (another defunct carrier that previously flew to Hawaii) is that it does not have long range narrow-body aircraft in its fleet. All of its flights beyond Hawaii use wide-bodies with 250-300 seats.
This meant that Hawaiian Airlines couldn't profitably serve routes with lower demand. While it offers connections in Honolulu to the other islands, most travelers understandably prefer a nonstop flight.
The San Jose-Honolulu route -- which has more demand than many routes to Kona and Lihu'e -- is a case in point of Hawaiian's dilemma. Hawaiian Airlines reduced service on this route last fall and cut it altogether in early 2014 due to weak profitability. Then it restarted daily service on the route in mid-May. Clearly, the route is right on the margin between being viable or not.
A solution is coming
In order to avoid situations like this in the future, Hawaiian Holdings placed a firm order for 16 Airbus A321neos last year. It also has purchase rights for nine additional A321neos. These planes are expected to seat 190 passengers and will be some of the most fuel-efficient planes available when they debut in a few years.
Hawaiian Airlines will be able to use the A321neos in 3 different ways to improve its results. First, Hawaiian Airlines can take advantage of the lower seating capacity to add routes that could not handle a wide-body plane.
Second, Hawaiian Airlines can "downgauge" on marginal routes by swapping out a wide-body plane in favor of a smaller A321neo. This would dramatically improve the profitability of routes where Hawaiian can't reliably fill a wide-body. For example, this might solve the carrier's issues on the San Jose-Honolulu route.
Third, Hawaiian Airlines can use the A321neos to add capacity in smaller increments. Swapping two 190-seat A321neos for a 294-seat A330 increases seat capacity by 29%, whereas flying two wide-bodies would double capacity.
These strategies can also be combined. For example, instead of flying one A330 into Honolulu each day, Hawaiian could fly one A321neo to Honolulu and one A321neo to Maui. This would allow it to offer nonstop flights to two islands, while increasing its seat capacity by less than 30%.
Higher earnings ahead
The A321neo will allow Hawaiian Airlines to keep its costs down. But what makes it a game changer is that it will enable Hawaiian to better match capacity to demand both on existing routes and potential new routes. The A321neo will give Hawaiian Airlines the flexibility it needs to compete with Alaska Air on routes to Hawaiian destinations other than Honolulu.
In the long run, this will be good for Hawaiian Holdings shareholders in two ways. First, the arrival of the A321neo will increase the company's growth potential by making a variety of new routes feasible. Second, substituting the A321neo for wide-body aircraft will boost Hawaiian's profit margin. Both impacts will lead to significantly higher earnings at Hawaiian Holdings.
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Adam Levine-Weinberg owns shares of Hawaiian Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.