Over the past two years or so, Hawaiian Airlines parent Hawaiian Holdings (HA +0.00%) has suffered severe margin compression from rising competition in many of its markets. The carrier is on track to post a full-year adjusted pre-tax margin between 9% and 10% in 2019, down from a peak of around 18% in 2016 and 2017.
To its credit, management has been working hard to shore up Hawaiian Airlines' business model to ensure its long-term competitiveness. On Monday, Hawaiian started to roll out one of its most important profit growth initiatives: a Main Cabin Basic fare option. This -- along with some of the carrier's other recent strategic moves -- could help Hawaiian Holdings return to profit growth next year.
The promise of Main Cabin Basic
Basic economy pricing was introduced to the U.S. market by Delta Air Lines in 2012 as a tool to make it easier to compete against budget carriers. By creating a fare type with additional restrictions -- most notably, no advance seat selection -- Delta found it was able to capture price-sensitive travelers with low fares while coaxing most customers to pay more for tickets with fewer restrictions.
In the past few years, basic economy pricing has gone mainstream. Today, all of the top five U.S. airlines have introduced some form of basic economy, with the notable exception of Southwest Airlines (LUV 0.50%). (JetBlue will follow suit by the end of 2019.) In each case, it has been very successful.
While Southwest Airlines plans to grow substantially on West Coast-Hawaii routes in the coming years, most of Hawaiian's competition today comes from airlines that have introduced basic economy pricing. As a result, it has been at a competitive disadvantage, which has contributed to its recent unit revenue declines.
Hawaiian Airlines' lack of a basic economy offering has been a competitive disadvantage. Image source: Hawaiian Airlines.
Its Main Cabin Basic fares will look similar to most of its rivals' basic economy offerings. The main drawback versus traditional coach fares is that you cannot select a seat until check-in. Main Cabin Basic ticket holders will also board last, elite frequent fliers won't receive bonus miles, upgrades are not available, and flight changes are not permitted. Management estimates that upon full implementation, Main Cabin Basic will provide $15 million to $25 million of incremental annual revenue on mainland-Hawaii routes.
Testing begins
On Monday, Hawaiian Airlines announced that it had started selling Main Cabin Basic fares for travel beginning Oct. 21. But for now, the new fare type is available on only three of its roughly two dozen mainland-Hawaii routes, all from California: Los Angeles-Honolulu, Long Beach-Honolulu, and San Jose-Honolulu.
It didn't specify why it is going with a phased rollout, but it probably wants to test some aspects of the program before introducing it on all of its mainland-Hawaii routes.
Indeed, the three routes where the airline is testing Main Cabin Basic are very different from one another. The Los Angeles route is highly competitive. The other major carriers flying that route have implemented basic economy already. By contrast, Hawaiian Airlines is the only one flying to Hawaii from Long Beach. And its main competitor from San Jose to Honolulu is Southwest, which prides itself on its all-inclusive fares. Thus, Hawaiian will see how basic economy pricing affects its results in each of these distinct market types.
At the moment, Hawaiian Airlines is charging $30 each way to upgrade from Main Cabin Basic to a traditional main cabin fare on the Los Angeles and Long Beach routes. The fee is $20 each way for the San Jose route. Main Cabin Basic fares don't appear to be available on peak days when the round-trip fare would be more than $600.
Just one of Hawaiian's moves to return to profit growth
The carrier hasn't said when it plans to expand Main Cabin Basic pricing to more routes, but it probably won't take too long to roll it out broadly. As a result, the airline should be able to capture most of the estimated $15 million to $25 million revenue and profit upside in 2020.
In fact, the gains could be even greater, since many airlines have found that they underestimated the revenue potential of basic economy fares. Given that travel to Hawaii is dominated by couples and families, most customers will probably be willing to pay an extra $40 or $60 round trip for main cabin tickets so they can sit together.
The introduction of Main Cabin Basic isn't the only thing that will help lift Hawaiian Holdings' profitability in 2020. The arrival of the remaining Airbus A321neos that Hawaiian has ordered will boost its fuel efficiency. They will also enable faster growth next year, which should allow the carrier to reduce its nonfuel unit costs. And Hawaiian's planned joint venture with JAL for the Japan-Hawaii market is likely to receive tentative approval in the next few weeks. The joint venture should boost the company's profitability in Japan and open up new growth opportunities.
Right now, analysts seem extremely worried about the impact that Southwest Airlines' continued growth in Hawaii could have on Hawaiian Holdings. On average, they expect Hawaiian Holdings' adjusted earnings per share to fall to $3.77 next year after plunging more than 25% to around $4 this year. But thanks to the rollout of Main Cabin Basic and its other initiatives to boost revenue and reduce unit costs, Hawaiian has a good chance to exceed expectations in 2020.
