Arguably, the most influential financial metric that investors follow is EPS, or earnings per share. EPS figures are widely followed for a good reason. EPS represents the amount of a company's profit that is attributable to each individual share.
However, accounting oddities and one-time events often make reported EPS figures somewhat misleading relative to a company's underlying performance. Many companies report "adjusted EPS" to mitigate this problem. But sometimes, even that isn't possible or desirable.
Hawaiian Holdings (NASDAQ:HA) is one company where adjusted EPS may be a misleading metric today. Fortunately for shareholders, the company's underlying earnings performance is even better than its EPS figures seem to imply.
Hawaiian Airlines had a great year in 2014, as demand for travel to Hawaii remained strong -- particularly in the U.S. -- and fuel prices declined modestly. The company also benefited from its decision to cancel some underperforming routes to Asia, and redeploy that capacity to the U.S.
The net result was that Hawaiian's adjusted EPS soared more than 75% year over year, from $0.88 to $1.55.
Interestingly enough, the strong improvement in Hawaiian Airlines' fundamentals didn't come through in its GAAP EPS. Under standard accounting rules, Hawaiian had to mark down the value of its 2015 fuel hedges for the value they lost in late 2014 when oil prices plummeted. As a result, Hawaiian's GAAP EPS rose just 12%, from $0.98 to $1.10.
Share count also rising
While Hawaiian's adjusted EPS rose dramatically in 2014, the diluted share count used for its EPS calculation also rose quite a bit. Since the share count is the divisor in an EPS calculation, a higher share count reduces EPS, with all else being equal. While Hawaiian's adjusted EPS rose more than 75% in 2014, its adjusted net income more than doubled.
For the full year, Hawaiian's diluted share count rose from 53.2 million shares in 2013 to 62.8 million in 2014. For Q4, the share count was even higher, at 66.2 million.
Where are all these extra shares coming from? Some of them are stock options that Hawaiian Airlines executives exercised as the company's stock price soared from less than $6 in early 2013 to more than $20 by the end of 2014. However, most of the extra shares in the calculation are related to a convertible bond that the company issued in 2011.
The extra shares aren't all "real"
Accounting rules require Hawaiian Airlines to account for all of the shares it would have to issue to settle its convertible bond -- and a set of warrants it sold at the same time -- given the current stock price. When the stock was below $7.88, there was no dilutive impact. But as the stock has risen, the number of potential new shares has also increased. The 2014 full-year EPS calculation included an extra 4.9 million shares related to the convertible note, and 3.4 million shares related to the warrants.
However, what the official EPS calculation doesn't reveal is that Hawaiian hedged its convertible bond against potential dilution. This hedge means that Hawaiian will never have to issue the 4.9 million shares that it included in its 2014 diluted share count calculation.
Additionally, Hawaiian Holdings recently began to use excess cash to buy back some of its convertible debt. By the end of December, it had repurchased debt that could have converted to 1.9 million shares of stock.
Hawaiian's stock price has dropped more than 30% in the past two weeks. Given that the company still has excess cash, it has a great opportunity to repurchase more of its convertible debt. Since the convertible note hedges remain in place, retiring convertible debt is allowing Hawaiian to indirectly hedge its warrants.
Hawaiian's EPS is understated -- for now
Factoring in Hawaiian's convertible note hedges and convertible note repurchases, the company's diluted share count would be about 10% lower than what was actually reported in 2014. That would have added about 10% to its EPS.
By continuing to opportunistically repurchase its convertible debt, Hawaiian Holdings may be able to reduce the dilutive impact to zero by the time the bond matures next year.
Thus, even Hawaiian's adjusted EPS figures understate its underlying earnings growth, because they reflect short-term dilution that will ultimately be reversed by 2016. As the diluted share count returns to a more normal level next year, shareholders will be happy to see EPS growth accelerate relative to net income.
Adam Levine-Weinberg owns shares of 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.
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