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Hawaiian Holdings' EPS Soars, but Investors Still Don't Believe

By Adam Levine-Weinberg – Jul 26, 2017 at 8:05AM

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Hawaiian Holdings has exceeded investors' expectations repeatedly in recent years, but the stock still trades at a dirt-cheap earnings multiple.

Since the beginning of 2016, Hawaiian Airlines has been posting by far the best unit revenue results in the U.S. airline industry. This performance has driven strong earnings growth at parent company Hawaiian Holdings (HA 0.91%).

However, investors have been paying more attention to looming competitive capacity growth on the horizon. Most notably, United Continental (UAL -1.65%) plans to significantly increase service to Hawaii in 2018. As a result, Hawaiian Holdings shares have lost nearly a quarter of their value this year.

HA Chart

Hawaiian Holdings YTD Stock Performance, data by YCharts.

On Tuesday afternoon, Hawaiian Holdings released another stellar earnings report. Yet that didn't stop investors from sending the stock down even further.

Hawaiian Airlines is still thriving

In the first quarter of 2017, Hawaiian Airlines registered a strong 7.6% increase in revenue per available seat mile (RASM), allowing it to fully offset significant increases in fuel prices and non-fuel unit costs. As a result, Hawaiian's adjusted pre-tax profit jumped 17% year over year.

The momentum continued in the second quarter. Cost growth remained significant -- non-fuel unit costs rose 5.6% year over year, excluding special items -- but revenue per available seat mile soared 9.2%. This performance drove a 30% surge in adjusted pre-tax income.

A Hawaiian Airlines plane

Hawaiian Airlines' unit revenue soared 9.2% last quarter. Image source: Hawaiian Airlines.

Hawaiian's stellar RASM growth in 2017 has been driven by a combination of strong demand for travel to Hawaii, year-over-year capacity declines on many routes, and upgrades to its premium seating options. (Hawaiian Airlines is in the midst of reconfiguring its A330s to add 28 more extra-legroom seats in the economy cabin and replace recliner-style seats with luxurious lie-flat seats in the first class cabin.)

The third-quarter outlook is solid

Hawaiian Airlines' cost pressure will peak in the third quarter. The company expects adjusted non-fuel unit costs to increase 7%-10% this quarter. A tough year-over-year comparison is driving 2.5 percentage points of the increase, with rising wages and benefits and the timing of incentive pay accounting for another 4.5 percentage points. (Training costs related to Hawaiian's incoming A321neo fleet and higher airport costs contribute another 0.5 percentage points each.)

Meanwhile, unit revenue gains are likely to slow, relative to the torrid growth achieved in the first half of 2017, mainly because of tougher comparisons. For Q3, Hawaiian Airlines has projected that RASM will rise 4.5%-7.5% year over year. That showing should be sufficient for Hawaiian to approximately match the record adjusted EPS of $1.92 reported in the year-ago period.

All eyes on 2018 competition

Just three months ago, analysts expected Hawaiian Holdings' full-year EPS to fall about 7% in 2017. Now analysts expect EPS to be up about 7% this year. Nevertheless, Hawaiian Holdings stock has cratered, so that it now trades for less than eight times earnings.

Apparently, investors are terrified about what might happen when United Continental and other rivals increase capacity to Hawaii in late 2017 and early 2018. United in particular plans to add up to 11 extra daily flights to Hawaii starting in late December. This development will contribute to a projected double-digit increase in industry capacity between North America and Hawaii in Q1 2018.

However, investors are probably overestimating how much United's capacity growth will hurt Hawaiian Airlines. Some routes receiving additional flights aren't directly served by Hawaiian. In addition, United Airlines is a hub-and-spoke carrier, so a lot of the traffic on its flights is likely to originate from smaller "spoke" cities that Hawaiian Airlines doesn't serve at all.

Moreover, Hawaiian Airlines has additional tools available to avoid a nasty unit revenue decline next year. First, it will finally get the full revenue benefit of its A330 reconfiguration project in early 2018, after it completes the last of the retrofits.

A pair of flat-bed seats on a Hawaiian Airlines plane

Hawaiian will install flat-bed first-class seats on all of its A330s by early 2018. Image source: Hawaiian Airlines.

Second, the new A321neo fleet will allow Hawaiian to reduce capacity on certain routes if necessary. (The A321neos will have 189 seats, whereas Hawaiian's current long-haul planes are all in the 250- to 300-seat range.) Hawaiian Airlines should also reap substantial unit cost savings from replacing its aging Boeing 767s with A321neos, but most of those gains will come in 2019.

A giant overreaction

Tough comparisons and resurgent industry capacity will clearly affect Hawaiian Airlines' unit revenue growth potential for 2018. However, unit cost growth should return to a much more normal inflation-like level, as the carrier laps the big cost headwinds it currently faces.

In sum, there's no reason to expect a massive earnings wipeout at Hawaiian Holdings next year. By 2019, EPS growth could reaccelerate as the company starts to reap the full benefit of its fleet transition in the form of lower unit costs. As a result, Hawaiian Holdings stock is a huge bargain at its after-hours trading price of about $43.

Adam Levine-Weinberg owns shares of Hawaiian Holdings and is long August 2017 $46 calls on Hawaiian Holdings and short October 2017 $50 puts on Hawaiian Holdings. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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