For the last 3 years, Hawaiian Holdings (NASDAQ:HA) has been on a growth tear. Since late 2010, the company has added service on its Hawaiian Airlines subsidiary to 10 new destinations, mostly outside the U.S. It will add yet another new city -- Beijing -- next April. This rapid expansion has been great for revenue growth, but it hasn't helped Hawaiian's earnings at all.
Hawaiian's management has acknowledged that to get profit to an acceptable level, the company now needs to focus on maturing its network, rather than adding even more new cities . From a growth perspective, this means that Hawaiian will look to increase service to the cities it already serves .
The company's recent announcement that it will add a fourth weekly flight between Brisbane and Honolulu is a good first step . For the next five years, Hawaiian's growth will primarily come from offering more frequent flights on its current routes: a process that should lead to sustainable profit growth.
The promise (and cost) of smaller markets
The first half of Hawaiian's recent expansion focused on large, relatively well-developed travel markets. The carrier added service to Honolulu from Tokyo, Seoul, Osaka, Fukuoka, and New York between late 2010 and the middle of 2012.
The second part of Hawaiian's expansion has targeted a combination of smaller cities (Sapporo, Brisbane, Auckland, and Sendai) and less well-developed leisure travel markets (Taipei and Beijing). One advantage of growing into smaller markets is that they have less competition. Indeed, Hawaiian has no direct competition on its routes to Sapporo, Brisbane, and Sendai.
If Hawaiian can establish a strong brand in these markets, it will be hard for competitors to challenge it in the future. On the other hand, in smaller markets, it is harder to fill airplanes. Hawaiian Airlines needs to stimulate demand for travel to Hawaii through a combination of advertising, working with local travel agents, and partnering with tour operators. It takes time to build this demand from scratch.
In order to keep supply roughly in line with demand, Hawaiian decided to enter the markets in its second group with 3 flights a week, rather than daily service. However, this is less cost-efficient. Hawaiian needs gate space and local employees wherever it operates, and these (relatively) fixed costs can be spread over more passengers with more weekly flights. Offering more schedule options can also create some incremental demand.
The first move
On a variety of occasions this year, Hawaiian Airlines' executives have noted that demand has been stronger than expected on the Brisbane route . During peak travel periods, Hawaiian has added extra flights with good success .
In fact, back in August, Peter Ingram -- Hawaiian's Chief Commercial Officer -- told Australian media outlets that the airline hopes to eventually grow to daily service between Brisbane and Honolulu. Starting in the spring, Hawaiian will inch closer to that goal, with an extra year-round weekly flight.
Looking further ahead, Hawaiian has some unallocated capacity available next fall. Depending on how demand develops over the next several months, it could move to daily Brisbane-Honolulu flights then. Alternatively, some of its other new routes that are currently being served 3 times weekly could merit additional capacity.
The success of Hawaiian Airlines over the next five years or so depends to a large extent on how well demand develops in the carrier's new markets. If Hawaiian can build up to daily (or near-daily) service in the markets it has recently entered, it will solidify its market position for the long-term. Moreover, by better leveraging fixed costs on the ground, increasing frequencies should boost Hawaiian's margins -- assuming that demand is sufficient.
Investors should keep an eye on how demand develops in Hawaiian's new international markets over the next few years, now that the carrier is planning to take a break from adding new cities. The strategy of growing through more frequent service to destinations Hawaiian already serves holds significant promise for the company and its investors.
Fool contributor Adam Levine-Weinberg owns shares of Hawaiian Holdings and is long April 2014 $8 calls on Hawaiian Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.