Hawaiian Holdings (HA 6.38%) stock was flying high in mid-2017. However, it pulled back dramatically in the second half of the year, after United Continental decided to expand its presence in the mainland-Hawaii market and Southwest Airlines (LUV 6.01%) announced plans to start flying to Hawaii. The fear was that rising competition would undermine Hawaiian's unit revenue.
Southwest Airlines hasn't even begun service to Hawaii, but unit revenue trends have already deteriorated dramatically at Hawaiian Airlines. This week, the carrier lowered its fourth-quarter revenue per available seat mile (RASM) guidance, acknowledging incremental weakness.
With Southwest still planning to begin flights between California and Hawaii in early 2019, investors are understandably nervous about Hawaiian Airlines' outlook. Management needs to use the company's investor day meeting (scheduled for next week) to explain how it will get RASM growing again.
The capacity glut finally catches up to Hawaiian Airlines
Industry capacity between the West Coast and Hawaii has been growing rapidly in 2018. Yet Hawaiian Airlines was able to fend off the challenge at first. During the first six months of 2018, industry capacity between the U.S. West Coast and Hawaii surged 13.5%, but Hawaiian was still able to post a 2.7% RASM increase -- albeit on the back of strong results for international routes and interisland flights.
By contrast, RASM declined 2% in the third quarter, even though industry capacity growth had started to tail off by then. This was significantly worse than the roughly flattish results that management had predicted early in the quarter.
Entering the fourth quarter, Hawaiian Airlines' forecast called for slightly better results, with RASM between being down 2.5% and up 0.5% year over year. However, management's initial guidance has proven to be overly optimistic for the second straight quarter. On Wednesday, the airline said it now expects RASM to decline 3% to 5% this quarter.
Hawaiian blamed the guidance cut on traffic growth in the U.S.-Hawaii market no longer keeping up with capacity growth. This has negatively impacted pricing in the market. Demand has also been lower than expected on interisland routes, particularly to Hawaii's Big Island.
Another big threat is on the way
As of October, industry capacity between North America and Hawaii was set to rise about 7% in the fourth quarter, according to Hawaiian Airlines CEO Peter Ingram. However, based on published schedules, industry capacity looked "pretty flat" for the first half of 2019, as airlines will soon lap the many capacity increases implemented in late 2017 and early 2018.
Slower industry capacity growth should lead to better unit revenue results for Hawaiian Airlines and its peers on mainland-Hawaii routes. But there's a big catch. Southwest Airlines hasn't published any schedules for its Hawaii flights yet, as it is still waiting on final FAA approval.
When that approval does come -- which will likely be within the next few weeks -- Southwest plans to move aggressively in building up service to Hawaii. By the spring, the popular low-fare carrier could be offering a dozen or more daily round-trips between its California gateway cities and Hawaii. That would drive industry capacity growth back into the high-single-digit range at a minimum, potentially causing another downturn in the pricing environment.
Does Hawaiian Airlines have the tools to fight back?
The most likely scenario right now is that Hawaiian Airlines will benefit from a slight respite in industry capacity growth next quarter. However, industry capacity growth will likely be back to its recent pace (if not higher) by the second quarter of 2019.
That doesn't mean Hawaiian is doomed, though. For one thing, it expects nonfuel unit costs to decline and fuel efficiency to improve dramatically next year. A recent pullback in oil prices could further reduce the carrier's unit costs, helping it cope with lower unit revenue.
Furthermore, Hawaiian Airlines has recently replaced Boeing 767s (which are being retired) with smaller Airbus A321neos on several routes, with others switching over in the next few months. Many of these aircraft changes have been in the markets that Southwest Airlines plans to enter. Thus, the influx of new seats from Southwest Airlines on those routes will be partially offset by Hawaiian Airlines using smaller planes there.
Hawaiian's new A321neos also have a large number of extra-legroom seats, unlike the Boeing 767s, which should bolster ancillary revenue.
Will this be enough to stabilize Hawaiian Airlines' profitability next year? Does the carrier have any other tricks up its sleeve to improve its RASM performance in 2019? These are key questions that management must answer at next week's investor day meeting.