In an instant last week, Hawaiian Holdings' (NASDAQ:HA) earnings per share soared by more than 10%. This came from the combination of a recent financial transaction and some obscure accounting rules. The change highlights just how cheap Hawaiian Holdings stock is.
The situation, in a nutshell
In 2011, Hawaiian Holdings issued $86.25 million of convertible debt due in 2016, which holders could convert to roughly 10.9 million shares at a price of about $7.88/share. At the same time, Hawaiian entered into two more transactions with some large financial institutions, buying hedges for its convertible notes while selling warrants for its stock.
This complicated piece of financial engineering is actually a fairly common tactic for companies that want to issue convertible debt. By buying convertible note hedges and selling warrants, they can ensure that they don't have to issue new shares unless the stock price rises a lot. (Of course, they have to pay a cash premium to do this; you can't get something for nothing!)
In the case of Hawaiian Holdings, this additional pair of transactions raised the effective conversion price from around $7.88/share to $10/share. However, Hawaiian Holdings stock has soared far above both of these levels, ending Monday at $36.77.
In the past year, Hawaiian has repurchased most of the convertible debt it issued back in 2011. But the convertible note hedges and warrants have remained on the books.
The hedges and warrants almost exactly offset one another. But accounting rules have required Hawaiian Holdings to include the dilutive impact of the warrants in its share count while excluding the offsetting hedges. This has artificially depressed Hawaiian's EPS.
Hawaiian Holdings simplifies its financial situation
The convertible note hedges were due to expire in March 2016, with the warrants expiring later in the year. However, last week, Hawaiian Holdings agreed to terminate both financial instruments, receiving net proceeds of roughly $19 million in the process.
That means Q4 will be the last quarter that the warrants have any impact on Hawaiian's share count. In Q3, the warrants added 6.35 million shares to the diluted share count. With the warrants on the books, Hawaiian's GAAP EPS came in at $1.15 for the quarter. Without the warrants, EPS would have been about 12% higher, at $1.29.
For 2016, Hawaiian's share count will now be much lower than it otherwise would have been. With no further share buybacks, the company would probably have about 54 million to 55 million shares outstanding next year.
The share count will likely be even lower than that, though. Hawaiian Holdings ended Q3 with $62 million left on its share buyback program: enough to repurchase about 1.7 million shares at the recent stock price. Furthermore, it remains well above its liquidity target. Hawaiian could potentially announce an increase to its buyback plan as soon as its analyst meeting next week.
2016 analyst estimates seem low
Analysts currently expect Hawaiian Holdings' adjusted EPS to rise 6% year over year to $3.21 in 2016. However, it now looks like the company's share count will be down by double digits next year. Even with flat net income, EPS could rise by something like 15%.
If oil prices remain on their current trajectory, flat net income should be very achievable (and perhaps beatable). Hawaiian is on pace to pay a little more than $2/gallon for jet fuel this year due to substantial hedging losses. Those hedging losses will moderate in 2016, driving another double-digit decline in fuel costs. This should offset any continued unit revenue pressure.
Thus, Hawaiian Holdings could potentially produce EPS of about $3.50 next year. If so, the stock is still trading for less than 11 times forward earnings despite its stellar performance this year. That means it may still have some room to run.