A few years ago, Allegiant Travel (NASDAQ:ALGT) purchased a set of six used Boeing 757 airplanes and announced big plans to use them for flights to Hawaii. The island state seemed like a natural extension of Allegiant's business model of offering budget flights and vacation packages from small cities to warm-weather leisure destinations.
But Allegiant has had much more trouble than expected in making Hawaii flights work. The airline quickly cut back many of its Hawaii routes to seasonal service, and it recently canceled all but two of those routes.
Furthermore, Allegiant announced last week that it is writing down the value of its Boeing 757 fleet by $43.2 million due to reduced expectations for the fleet's cash flow generation and life span. Does this mean Allegiant is admitting defeat in Hawaii?
Trouble in paradise
When Allegiant began its Hawaii service, it focused on flying from smaller cities that didn't have any nonstop service to Hawaii, such as Spokane, Washington; Boise, Idaho; and Stockton and Fresno in California. This made sense, since Allegiant has been successful flying from small cities to other leisure destinations such as Las Vegas and Florida.
Clearly, that model didn't work for Hawaii. Routes from small cities were the first to get dropped as Allegiant pulled back from the market. The two remaining Hawaii routes are from the major markets of Los Angeles and Las Vegas. These routes are clear outliers in Allegiant's route network.
What went wrong?
Allegiant has not said much about why its Hawaii flights failed to meet expectations, other than that the market proved highly seasonal. One contributing factor might be the size of the Boeing 757, which has 218 seats in Allegiant's configuration. By contrast, Allegiant's other planes have 150 to 177 seats, making them easier to fill in smaller markets.
The long distance of flying to Hawaii was probably another key factor. Allegiant's average stage length is less than 1,000 miles, while Hawaii is about 2,500 miles from the U.S. mainland. This makes fuel a much more significant expense. Second, Allegiant's normal model of having one flight crew complete a round-trip and return to base in a single day doesn't work for flights to Hawaii, increasing non-fuel costs.
Lastly, strong travel demand can actually hurt Allegiant because hotels don't have to offer big discounts to fill rooms. That means Allegiant can't offer great prices on full travel packages. Visitor arrivals in Hawaii reached a record of 8.2 million last year, putting Allegiant and its price-sensitive customers at a disadvantage.
Allegiant has learned from its experience in the past two years that it will need to adapt its business model if it wants to succeed in Hawaii. Some of the problems it has faced are out of management's control, such as fuel prices and the availability of affordable hotel rooms.
However, Allegiant might be able to return to growth in Hawaii in a few years. The company has added 11 Airbus A319 and A320 aircraft to its fleet in the past two years. Allegiant has another 23 used Airbus planes scheduled to enter its fleet between now and 2018, and it is actively looking for more aircraft to support growth in 2016 and 2017.
Over the next five to 10 years, Allegiant is likely to move to an all-Airbus fleet, as its MD-80s and 757s will be nearly 30 years old by then. It would be relatively straightforward for Allegiant to certify A319s (and possibly A320s) for over-water service.
This could make Hawaii service much more viable. These planes are significantly more fuel-efficient than Boeing 757s, and Allegiant's A319s only have 156 seats, making it easier to fill them at profitable fare levels. For now, Allegiant has better opportunities for its Airbus fleet, but eventually it could look to Hawaii again as a potential source of profitable growth.
Adam Levine-Weinberg owns shares of Boeing. 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.