Shares of Hawaiian Holdings (NASDAQ:HA) cratered on Monday, falling 11% as Southwest Airlines (NYSE:LUV) finally began selling tickets for its long-awaited Hawaii flights. The stock continued to move downward on Tuesday.
However, investors and bearish analysts are overestimating the extent to which Southwest's entry into the Hawaii market will hurt Hawaiian Airlines -- especially in the long run. As a result, this looks like a great time for patient, long-term investors to buy Hawaiian Holdings stock.
Hawaii ticket sales begin with a splash
Southwest Airlines launched Hawaii ticket sales by offering flights for as little as $49 one way from Oakland and San Jose to Honolulu on Oahu and Kahului on Maui. Oakland-Honolulu flights begin on March 17, and the flight schedule is currently set to ramp up to six daily round-trips between the mainland and Hawaii by late May.
Not surprisingly, the rock-bottom fares that Southwest offered for springtime travel to Hawaii elicited a huge customer response. Within a few hours, all of the $49 fares had disappeared. By Tuesday morning, there were only a handful of flights left for less than $100 one way, with round-trip fares coming in between $300 and $500 on most combinations of days (and even higher on the busiest travel days).
As a result, Hawaiian Airlines hasn't needed to match extremely low sale fares from Southwest. Indeed, Southwest Airlines appeared to sell a substantial chunk of its inventory for the spring just in the first day of availability.
That shouldn't be a big shock. Southwest operates the most daily flights to, from, and within California of any airline. There has been massive pent-up demand for Hawaii flights among its huge base of loyal customers ever since the carrier first announced its intention to fly to Hawaii in late 2017. Yet by late May, when Southwest will be operating all six daily round-trips to Hawaii that it has currently scheduled, the low-fare carrier will still provide just 1,050 seats a day from Oakland and San Jose to Hawaii.
For comparison, last June, airlines offered an average of 6,566 seats a day from the three Bay Area airports (including San Francisco) to Hawaii and 17,196 seats a day from California as a whole to Hawaii. Thus, the extra capacity Southwest has added to the market so far is little more than a drop in the bucket. It's probably not even enough to meet all of the incremental demand that Southwest is stimulating -- from people redeeming Rapid Rewards points, for example.
The upshot is that while Southwest Airlines made a dramatic entrance, its presence in the California-Hawaii market isn't likely to have a big impact on unit revenue at rivals like Hawaiian Airlines next quarter, or even during the busy summer travel season.
Looking further out
Southwest plans to add Hawaii flights from two more California cities later this year: San Diego and Sacramento. It will also begin nonstop service to two more Hawaiian destinations: Kona on the Big Island and Lihue on Kauai. As the carrier ramps up its full Hawaii schedule over the next six months or so, it will start to have a bigger impact on the overall supply demand dynamic in the market.
In the short run, that could pressure Hawaiian's unit revenue, particularly during off-peak periods like the fourth quarter and the first quarter. But in the long run, Hawaiian Airlines should be able to continue generating ample profits from the West Coast-Hawaii market.
First, Hawaiian will roll out a "basic economy" fare later this year. In recent years, other airlines have found that such offerings minimize the unit revenue impact of matching low-fare airlines' prices. Second, first-class and extra-legroom seats account for more than 30% of the seating mix on Hawaiian Airlines' transpacific fleet and an even higher proportion of revenue. Southwest offers single-class service, so it can't disrupt this part of Hawaiian's business. Third, Hawaiian Airlines can tactically reduce capacity in West Coast markets if necessary, redeploying those airplanes on long-haul routes to Asia, Australia, or the U.S. East Coast to boost profitability.
Targeted price-matching in Hawaii
Investors may have found Southwest Airlines' decision to enter the interisland market -- where Hawaiian Airlines has had a near-monopoly recently -- even more worrisome. Southwest will begin flying four times a day between Honolulu and Kahului in late April. It will add four daily round-trips between Honolulu and Kona in mid-May.
Southwest launched these routes with introductory pricing as low as $29 one way on Tuesdays, Wednesdays, and Saturdays this spring. Even on the busiest travel days, Southwest's starting one-way fare for interisland travel is no more than $59. In contrast to Southwest's mainland-Hawaii routes, these bargain fares did not sell out immediately.
This might seem like terrible news for Hawaiian, which gets about a quarter of its revenue from the interisland market -- and earns very high margins there. The reality is more complicated.
It's true that Hawaiian Airlines has been charging a minimum of $69 one way for interisland tickets recently. Some tickets cost $100 or more, even if purchased a month or more in advance. Hawaiian will match Southwest's lower fares for most days after the latter enters the interisland market, which will have a negative impact on unit revenue.
However, Hawaiian Airlines operates up to 27 daily Honolulu-Kahului round-trips and up to 19 daily Honolulu-Kona round-trips. On a typical day, it is matching Southwest's fares on just a few flights per day that leave around the same time as a Southwest Airlines flight. There seems to be little to no impact on pricing for the vast majority of Hawaiian's interisland flights.
Southwest's low fares will stimulate lots of leisure traffic within Hawaii. However, Hawaiian's superior schedule will allow it to maintain a stranglehold on the lucrative market for business travel and other nondiscretionary trips. While Southwest Airlines will add flights to Lihue later this year and could try to increase capacity somewhat on its interisland routes in the future, severe gate constraints in Honolulu mean it won't come close to matching Hawaiian Airlines' interisland schedule at any point in the foreseeable future.
Less than meets the eye
The bottom line for investors is that while Southwest Airlines' entry into the Hawaii market will be great for travelers, it won't hurt Hawaiian Airlines all that much. Instead, it will stimulate additional trips both within Hawaii and from the mainland to Hawaii while having a modest impact on industry unit revenue in the long run.
With Hawaiian Airlines stock trading for close to six times forward earnings, this could be a great time to buy for long-term investors willing to ride out a little short-term volatility.