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1 Stock I'm Buying More Of in 2018

By Adam Levine-Weinberg – Jan 21, 2018 at 6:45AM

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One airline stock is trading for less than 7 times trailing earnings -- even though the company is likely to achieve double-digit EPS growth in 2018.

Hawaiian Holdings (HA 2.24%) has posted impressive earnings-per-share growth over the past several years. As recently as 2014, adjusted EPS was just $1.55. However, EPS doubled to $3.09 in 2015 and continued to surge higher in 2016, reaching $5.19. During 2017, Hawaiian Holdings did an impressive job of offsetting rising fuel and labor costs to keep EPS moving higher. On average, analysts expect it to post full-year EPS of $5.62.

Not surprisingly, Hawaiian Holdings shares skyrocketed as EPS growth took off, roughly tripling from around $20 in early 2015 to a peak of $60 in late 2016. But since then, Hawaiian Holdings stock has given back more than half of its gains. It currently sits near the $38 mark.

HA Chart

Hawaiian Holdings stock performance, data by YCharts.

Fears about rising competition from United Continental (UAL -0.72%) and Southwest Airlines (LUV 0.03%) have caused this bizarre stock slide. However, these worries have been blown way out of proportion. As a result, I purchased additional shares of Hawaiian Holdings stock earlier this month -- and I just might buy more in the weeks ahead.

Strong revenue outlooks for the interisland and international markets

Like other airlines, Hawaiian Holdings will face significant cost pressure in 2018 from rising jet fuel prices. The big question is whether the carrier will be able to offset this cost pressure with further increases in revenue per available seat mile (RASM).

On its intra-Hawaii routes, which account for about a quarter of its revenue, Hawaiian Airlines could be primed for explosive unit revenue growth. For much of 2017, RASM was under pressure in this market, as Island Air, Hawaiian's main rival within Hawaii, expanded rapidly. But in mid-November, Island Air folded, leaving Hawaiian with a virtual monopoly on interisland routes. This development could potentially drive double-digit RASM growth on these routes during 2018.

International routes -- which also account for roughly a quarter of Hawaiian's revenue -- could be another source of strength this year. Hawaiian Airlines will get a big RASM bump in 2018 from rising fuel surcharges in Japan, which is by far its largest international market.

A Hawaiian Airlines plane flying over the ocean, with mountains in the background

Hawaiian Airlines may post strong international unit revenue growth in 2018. Image source: Hawaiian Airlines.

The weakening dollar represents another significant tailwind. Hawaiian Airlines sells most of its tickets in foreign currency for its international routes, and those foreign-currency proceeds are now worth more in dollar terms. In addition, a weaker dollar makes travel to the U.S. more affordable for international tourists, potentially boosting demand.

International unit revenue surged 12% year over year in Q3, the most recently reported quarter. International RASM growth could slow in 2018, but it should remain strongly positive.

The competitive threat is not as big as it seems

Investors' most immediate worry is that rising competition on West Coast-Hawaii routes will undermine unit revenue there. (Hawaiian Airlines gets about half of its revenue from the West Coast-Hawaii market.) However, this outlook is based on an overly simplistic analysis of the planned growth by United Continental and Southwest Airlines on these routes.

Last month, United added numerous additional flights from San Francisco and Los Angeles to secondary destinations in Hawaii -- i.e., not Honolulu. This change alone will limit the impact on Hawaiian Airlines, which primarily flies to Honolulu today.

At first glance, Southwest Airlines' decision to start flying to Hawaii appears more worrisome. After all, Southwest has been known to undercut rivals by as much as 15%-25% when entering a new market. Furthermore, it already has a big customer base in many West Coast cities.

That said, Hawaiian Airlines is likely to get a huge revenue premium over Southwest Airlines on West Coast flights. First, more than 30% of the seats on its A321neos and A330s are in first class or come with extra legroom, whereas Southwest has an all-coach configuration. Second, Hawaiian Airlines serves complimentary meals even in coach, while Southwest Airlines only offers snacks. Third, many customers appreciate the authentic Hawaiian feel of traveling on Hawaiian Airlines.

A Hawaiian Airlines A321neo parked on the tarmac

Hawaiian Airlines is increasing its premium seat inventory. Image source: Hawaiian Airlines.

Lastly, as Hawaiian Airlines retires its remaining 767s in favor of new A321neos over the next year, it will have to reduce capacity on at least half a dozen existing routes. It can strategically target these capacity cuts in markets where competitive capacity is set to surge.

One other common worry is that Southwest Airlines will eventually enter the interisland market, providing much stiffer competition than Island Air ever did. It's true that Southwest historically thrived on short-haul routes like the 100- to 200-mile hops that are common in Hawaii.

However, Southwest has evolved over the years. Today, its planes are larger and heavier -- and more suited to flying longer routes. Furthermore, it has no infrastructure or crew bases in Hawaii as of now. Thus, even Southwest Airlines may be unable to challenge Hawaiian Airlines in the interisland market.

Tax reform and share buybacks will add to EPS growth

Right now, most analysts expect Hawaiian Airlines' EPS to decline in 2018. That isn't likely to occur, though. First, the recently implemented tax reform law will significantly reduce the company's tax rate. This change should boost EPS by about 22%.

Second, Hawaiian's management has taken advantage of the plunging stock price to ramp up share buybacks. The company has retired about 4% of its shares just in the past two quarters, and the board authorized a new $100 million share-repurchase program last month.

Third, to the extent that Southwest Airlines' entry into the West Coast-Hawaii market could pinch profits, that expansion won't begin until late 2018 at the very earliest.

Even if Hawaiian Airlines faces modest margin pressure on its West Coast routes, strong momentum in the interisland and international markets should limit the impact on pre-tax profit. The combined impact of tax reform and share buybacks would then boost EPS by as much as 30%. With shares trading for less than 7 times trailing earnings, Hawaiian Holdings looks like a screaming buy -- and I am loading up on the stock for 2018.

Adam Levine-Weinberg owns shares of 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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