Alaska Air (NYSE:ALK) is an anomaly within the U.S. airline industry. While other carriers have been scurrying to find merger partners in recent years, Alaska has happily remained single. Indeed, Alaska has one of the highest profit margins in the airline industry, despite being just a fraction of the size of the country's largest carriers -- carriers that have claimed that they need to merge and gain scale to remain competitive.
One of Alaska's biggest secrets to success has been its diversified network, which allows it to move capacity around during the year to take advantage of different seasonal demand patterns. By tailoring capacity to demand in each market, Alaska can stay solidly profitable throughout the year.
One competitor -- Hawaiian Holdings (NASDAQ:HA) -- is now hoping to take a page out of the Alaska Airlines playbook. A few years ago, Hawaiian's management recognized that it relied too heavily on travel between the U.S. West Coast and Hawaii to make money.
Since then, it has expanded rapidly, and concentrated its growth on other regions, particularly Asia and Oceania. Ultimately, I expect Hawaiian to see strong margin growth over the next several years, as it becomes more like Alaska in its ability to shift capacity seasonally across its network.
Diversification = profit
As recently as 2001, Alaska Air devoted 86% of its capacity to service within the U.S. West Coast and Alaska. Today, that flying accounts for just 48% of Alaska's capacity; flights to Hawaii take up another 20%, transcontinental (and mid-continental) flights represent 22% of capacity, and the balance consists of flights to Mexico and Canada.
This diversification has allowed Alaska to reallocate capacity to warm weather destinations such as Mexico and Hawaii in the winter, when most other routes face seasonal weakness. Not only can Alaska change flight frequencies over the course of the year, it can also can use different size aircraft according to local demand trends. While Alaska operates an all-Boeing (NYSE:BA) 737 fleet, its 737s range in seating capacity from 124 to 181. (It even has a few part-passenger, part-freighter airplanes with 72 seats!)
While other factors such as stringent cost management have also benefited Alaska in recent years, operating a more flexible route network has been critical to boosting the company's margins. After reporting a loss in 2008, Alaska generated a pre-tax margin of 6% in 2009. By 2012, this had grown to 11%, which is very impressive for an airline.
New plan for Hawaiian
Hawaiian Airlines has embarked on a diversification plan of its own since late 2010. It has established several new routes to Japan, along with new routes to South Korea, Australia, New Zealand, Taiwan, and New York (its first route to the U.S. East Coast). Hawaiian also expects to begin flying to Beijing -- its first mainland China destination -- next April.
This expansion will give Hawaiian a much bigger opportunity to shift capacity across its route network according to seasonal demand patterns. In 2013, Hawaiian has started down this path by moving capacity from North America to Australia and New Zealand in the spring and fall, which are peak demand periods in those countries but weaker demand periods in the U.S. In the past several weeks, Hawaiian has offered 19 flights per week to Australia and New Zealand, compared to just seven per week in September 2012.
Hawaiian's recently begun service to Taiwan and its upcoming route to Beijing create similar opportunities. The Chinese New Year is a big travel period in China, but late January and February tend to be weak travel periods elsewhere. Hawaiian may be able to take advantage of this counter-seasonal spike in demand by moving capacity from other parts of its network to China in late January and early February.
Looking a little further out, Hawaiian will gain added flexibility in 2017 and beyond, when it starts adding 190 seat A321 NEO aircraft to its fleet. Today, Hawaiian's long-range fleet is made up of widebody planes that seat 250-300 passengers. Adding the A321 NEO to its fleet will allow Hawaiian to change the aircraft size used for different markets seasonally.
Foolish bottom line
In the past few years, Alaska Airlines has delivered strong financial results due in part to its diversification across markets with different seasonality. This has allowed it to post strong results four quarters per year; not just in the spring and summer peak seasons.
By contrast, excessive seasonality has been an Achilles' heel for Hawaiian Airlines recently. Analysts expect the company to earn more than 80% of its 2013 annual profit during the summer quarter! However, Hawaiian's ongoing expansion to markets with different seasonality -- such as Australia, New Zealand, and greater China -- should help the company post better results outside the summer peak season. If this strategy succeeds, Hawaiian will see strong margin expansion over the next few years, boosting shareholders' gains.