Virgin America Enters the Hawaii Market: Should Hawaiian Airlines Be Worried?

Last week, Virgin America (VA) made its long-anticipated announcement that it will begin flying to Hawaii. On Nov. 2, it will begin a daily round trip from San Francisco to Honolulu. On Dec. 3, Virgin America will add a route from San Francisco to Kahului..

Additionally, Virgin America CEO David Cush told the media last week that the carrier plans to add Los Angeles-Hawaii flights soon -- most likely in 2016.

Virgin America is starting its first Hawaii flights in November. Source: Virgin America.

Hawaiian Holdings (HA -0.08%) has built a $1 billion-plus business flying between the U.S. West Coast and Hawaii. Furthermore, it has had a codeshare and frequent flier partnership with Virgin America since late 2012. To what extent does Virgin America's entry into the Hawaii market threaten Hawaiian Airlines' core business?

The threat
From Hawaiian Airlines' perspective, the potential threat from Virgin America is twofold. First, Virgin America is adding seats to a market that is already suffering from some level of overcapacity. In January, Hawaiian Airlines Chief Commercial Officer Peter Ingram noted that airline capacity between the West Coast and Hawaii was on pace to hit record levels during the first half of 2015.

This overcapacity likely includes the San Francisco-Hawaii market. Late last year, Hawaiian Airlines added new daily service from San Francisco to Kahului to complement its long-standing San Francisco-Honolulu flights. (Note that these are the same two markets Virgin America is entering.)

The second aspect of the threat is that it will reduce the value of Hawaiian Airlines' partnership with Virgin America. Virgin America currently promotes Hawaiian Airlines flights on its website as a way to use the former's Elevate frequent flier points. Meanwhile, the codeshare arrangement lets customers book tickets through Hawaiian Airlines for travel between Hawaii and a variety of Virgin America destinations, like Chicago, Dallas, and Fort Lauderdale.

Hawaiian Airlines currently has a codeshare and frequent flier partnership with Virgin America. Source: Wikimedia Commons.

Virgin America now has an incentive to steer connecting traffic between Hawaii and the mainland across its own network. It can also offer award flights to Hawaii on its own flights. As a result, Hawaiian Airlines could be losing a partner and gaining a new rival.

Drop in the bucket
Fortunately for Hawaiian Airlines, the massive size of the West Coast-Hawaii travel market limits the threat from Virgin America's entry.

In 2014, airlines provided a total of 545,474 seats from San Francisco to Honolulu and 180,200 from San Francisco to Kahului, according to the Hawaii Tourism Authority. Hawaiian Airlines' San Francisco-Kahului route, which launched near the end of 2014, will add about 100,000 new seats in 2015, contributing to more than 50% capacity growth on that route.

By contrast, Virgin America will begin flying to Honolulu and Kahului with one flight a day (each) on a 149-seat A320 aircraft. Assuming the service operates 365 days a year, it will add 54,385 seats to each travel market. That would represent a 10% increase for Honolulu and a roughly 20% increase for Kahului (based on the higher expected 2015 capacity figure).

Those are certainly significant capacity increases, but they're not so massive that the market won't be able to absorb them within a couple of years. The overall rate of growth in San Francisco-Hawaii service won't be any higher than the 13.8% increase registered in the first two months of 2015.

Furthermore, if overcapacity weighs too much on fares, United Continental -- the top carrier in the San Francisco-Hawaii market -- would likely cut capacity to prop up the market. With four daily flights to Honolulu and three daily flights to Kahului, it could either drop a flight or use smaller planes for some flights while maintaining a dominant share of the market.

United Continental could potentially cut capacity from San Francisco to Hawaii to reduce slack in the market. 

Lastly, San Francisco is just one market for Hawaiian Airlines, representing about 10% of its West Coast-Hawaii capacity. Weakness there would have a noticeable but still manageable impact on overall results.

Coming to Los Angeles
Los Angeles is a bigger market for Hawaiian Airlines than San Francisco proper. The carrier operates four daily flights there year-round, rising to six daily flights during peak seasons.

Thus, Virgin America's eventual entry to the Los Angeles-Hawaii market will put more business at risk for Hawaiian Airlines. That's particularly true because most Virgin America-Hawaiian Airlines codeshare itineraries use connections in Los Angeles.

However, the Los Angeles-Hawaii market dwarfs even the San Francisco-Hawaii travel market in size. Last year, airlines deployed about 1.3 million seats between Los Angeles and Honolulu, along with nearly 600,000 seats between Los Angeles and Kahului, and more than half a million more seats spread across three smaller airports in Hawaii.

As a result, Virgin America offering two or three daily flights and 100,000-160,000 annual seats between Los Angeles and Hawaii won't have a big impact on the market dynamics. And since there is such a big local market, losing some connecting traffic won't hurt Hawaiian Airlines' competitiveness very much.

Not a major long-term threat
Virgin America's entry into the West Coast-Hawaii market could cause some short-term dislocation. This could put some pressure on Hawaiian Airlines' results next year. But in the long run, the amount of capacity Virgin America might add to the San Francisco-Hawaii and Los Angeles-Hawaii markets won't be game-changing.

Any negative impact on Hawaiian Airlines' overall profitability will be more than offset when Hawaiian Airlines adds the A321neo to its fleet beginning in late 2017.

The A321neo is about 30% smaller than the A330 widebodies used for most long-haul Hawaiian Airlines flights today. This will allow the carrier to fine-tune capacity in line with demand in its West Coast-Hawaii markets while also offering industry-leading unit costs. Thus, Hawaiian Airlines investors shouldn't sweat about this coming increase in competition.