Last month, Hawaiian Holdings (NASDAQ:HA) stock sagged after the company reduced its forecast for the second quarter. In its guidance update, the carrier highlighted unexpected cost pressures and the negative impact on bookings of increased volcanic activity on the Big Island of Hawaii.

However, on Tuesday afternoon, Hawaiian reported Q2 unit revenue results in the upper half of its revised forecast range, while beating its cost guidance. As a result, it smashed analysts' expectations for earnings per share, delivering results more in line with what Wall Street had expected prior to last month's guidance update. And while the company continues to face some headwinds, its forecast for the third quarter and beyond is very encouraging.

Profitability stays strong despite some bumps

In the second quarter, Hawaiian Airlines' revenue rose 6.8% on a 0.7% increase in revenue per available seat mile (RASM). This was in the lower part of the carrier's initial guidance range, which called for a 0% to 3% RASM gain, but above the midpoint of the updated range.

Meanwhile, adjusted nonfuel unit costs rose 4%, beating the company's updated cost forecast. As in the first quarter, much of Hawaiian Airlines' cost pressure related to its ongoing transition to a new fleet of Airbus (NASDAQOTH:EADSY) A321neos for many of its West Coast routes. Finally, the carrier's fuel bill surged last quarter, as economic fuel costs rose to $2.07 per gallon from $1.62 a year earlier.

A Hawaiian Airlines A321neo parked on the tarmac

Hawaiian Airlines isn't benefiting from its new Airbus A321neo fleet yet. Image source: Hawaiian Airlines.

The result was that Hawaiian Airlines posted an adjusted pre-tax margin of 13.7% in the second quarter, down from 19.6% a year earlier. Adjusted EPS came in at $1.44, down just slightly from $1.52 in the prior-year period. A lower tax rate, revenue growth, and share buybacks all helped mitigate the impact of Hawaiian's pre-tax margin decline on its EPS.

Margin pressure will continue in Q3 -- but it will still be a good quarter

For the third quarter, Hawaiian Airlines expects RASM to be roughly flat year over year (plus or minus 1.5 percentage points). The carrier's expansion pace will peak this quarter, with capacity up 7.5% to 9.5% year over year. This will boost revenue but is likely pressuring RASM. Management also noted that the slowdown in bookings related to volcanic activity is likely to have a bigger impact this quarter than it did in the second quarter.

Nonfuel unit costs are projected to rise 1% to 3% in the third quarter, as Hawaiian starts to reach an inflection point in its cost trajectory. However, economic fuel costs will surge again. The carrier currently expects to pay between $2.10 and $2.20 per gallon this quarter, up from $1.68 per gallon a year earlier.

All in all, Hawaiian Airlines' forecast suggests that its adjusted pre-tax margin will be roughly 17% this quarter. That's down from 22.2% in Q3 2017 (adjusted for new accounting rules that went into effect this year). Nevertheless, a quarterly pre-tax margin of 17% is very strong by airline industry standards.

Based on a 17% pre-tax margin, Hawaiian's EPS would be a little less than $2.00, up modestly on a year-over-year basis, but somewhat below the recent average analyst estimate of $2.02.

The outlook brightens going forward

Looking beyond this quarter, there are a lot of reasons for Hawaiian Holdings investors to be optimistic. For example, nonfuel unit costs are set to drop in the fourth quarter. Furthermore, nonfuel unit costs are expected to be flat at worst over the following two to three years.

The rapidly progressing A321neo fleet transition will be the main driver of these nonfuel unit cost improvements. Airbus is catching up on delayed A321neo deliveries, and Hawaiian Airlines will have eight A321neos in service by mid-August, with three more arriving by year-end. By early 2019, rather than having two inefficiently small subfleets, Hawaiian will have retired all of its 767s and will have a critical mass of A321neos to serve its lower-demand routes.

In addition to improving Hawaiian's nonfuel cost performance, the Airbus A321neos will have an even more dramatic impact on the carrier's fuel efficiency over the next year. These planes are probably about 30% more fuel efficient than the 767s they are replacing. Also, by allowing Hawaiian Airlines to reduce its capacity -- and increase the number of extra-legroom seats -- in lower-demand markets, the 767-to-A321neo fleet transition could lead to stronger unit revenue growth in Q4 and particularly in 2019.

Hawaiian Airlines could still see some volatility in its results over the next few years based on competitors' capacity decisions and fuel price fluctuations. However, the company continues to prove that it has built a durable and highly profitable business in the Hawaii travel market.