Hawaiian Holdings (NASDAQ:HA) has suffered from persistent margin erosion for the past two years. Growth on Hawaii routes by longtime rivals such as United Airlines -- combined with new competition from Southwest Airlines (NYSE:LUV) -- has undermined unit revenue at Hawaiian Airlines. Meanwhile, unit costs have continued to rise.

These trends continued last quarter, for the most part. That said, the Hawaiian Airlines parent still achieved a solid double-digit profit margin. Furthermore, Hawaiian continued to realign its route network during the quarter to enable better performance in the future.

Hawaiian Holdings results: The raw numbers

Metric

Q2 2019

Q2 2018

Change

Revenue

$712 million

$715 million

(0.5%)

Total unit revenue

13.81 cents

14.25 cents

(3.1%)

Adjusted cost per available seat mile excluding fuel

9.38 cents

9.35 cents

0.3%

Adjusted net income

$58.9 million

$73.3 million

(19.6%)

Adjusted pre-tax margin

11.4%

13.7%

(2.3 p.p.)

Adjusted EPS

$1.23

$1.44

(14.6%)

Data source: Hawaiian Holdings Q2 earnings release. Chart by author. P.P. = percentage points.

What happened with Hawaiian Holdings this quarter?

In mid-March, Southwest Airlines added six flights a day from Oakland and San Jose to Hawaii. (It has added some interisland service within Hawaii, too.) The grounding of the Boeing 737 MAX has caused a delay in launching additional routes, but Southwest's management recently indicated that the carrier will start selling tickets for flights from Sacramento and San Diego to Hawaii soon. Those flights will probably begin near year-end or early in 2020.

During the second quarter, Hawaiian Airlines continued its efforts to reshape its route network in light of this new competition from Southwest. Near the beginning of the quarter, it began flying nonstop from Sacramento to Maui -- front-running potential Southwest flights on that route -- while reducing capacity on its existing Sacramento-Honolulu route, which is sure to face competition from Southwest Airlines fairly soon. Around the same time, Hawaiian Airlines also began flying to Boston, offering the first nonstop flights between that big market and Hawaii.

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

Hawaiian Airlines began two new routes last quarter. Image source: Hawaiian Airlines.

Further tweaks to the domestic network are coming. Hawaiian Airlines recently announced that it will reduce capacity between San Diego and Honolulu starting in January, by switching from the Airbus A330 to the smaller A321neo on that route.

Hawaiian Airlines is also directing more of its growth to international markets in the face of heightened competition domestically. During the quarter, it announced the resumption of flights between Fukuoka, Japan and Honolulu. It will fly that route four times a week beginning in late November. Hawaiian also gained tentative approval to add a third daily flight to Hawaii from Tokyo's Haneda Airport starting in the spring of 2020.

For now, Hawaiian Airlines has to make the most of the route network it has. As expected, revenue per available seat mile declined again last quarter, but cost inflation was very mild. That allowed the company to limit its year-over-year pre-tax margin erosion to just 2.3 percentage points.

What management had to say

Despite the company's continued downward earnings trajectory, Hawaiian Holdings CEO Peter Ingram was fairly upbeat about the second-quarter results, considering the circumstances. Indeed, he described Hawaiian's performance as "strong."

Ingram continued, "For the last year and a half, we've delivered consistently solid operational and financial results while facing heightened competitive pressures head on. ... [N]o other airline is better suited to serve the needs of guests traveling to, from, and within the Hawaiian Islands than Hawaiian Airlines."

Looking forward

For the third quarter, Hawaiian Airlines expects another unit revenue decline. This time, RASM is on pace to fall 1.5% to 4.5% year over year.

A Hawaiian Airlines jet parked on the tarmac, with airstairs attached

Hawaiian Airlines' unit revenue hasn't bottomed out yet. Image source: Hawaiian Airlines.

Unfortunately, adjusted nonfuel unit costs are on track to rise 3.5% to 6.5% year over year this quarter. This seems to be a short-term blip, though, as the airline is still calling for a modest 1% to 2.5% increase in adjusted nonfuel unit costs for 2019 as a whole. In addition, Hawaiian will reap modest fuel cost savings in Q3, with a projected average fuel price of $2.11 per gallon -- down from $2.15 per gallon a year earlier -- and fuel efficiency likely to improve by about 3%.

In the third quarter of 2018, Hawaiian Airlines posted an adjusted pre-tax margin of 15.9%. Considering all the elements of its forecast for the current quarter, Hawaiian's adjusted pre-tax margin is set to fall by several percentage points compared to that result, but it should stay well within double-digit territory.

The biggest concern for Hawaiian Holdings shareholders is that Southwest Airlines is gearing up to significantly increase its presence in Hawaii. This will add to the headwinds facing the carrier. Hawaiian has numerous strategies to counter its new rival, ranging from its route network changes to cost reductions to the pending launch of cheaper "basic economy" fares. However, it remains to be seen whether those initiatives will be sufficient to get profit growing again at Hawaiian Holdings.