Hawaiian Holdings Stock Is a Buy on the Latest Southwest-to-Hawaii Rumors

Compared to virtually all of its airline peers, Hawaiian Holdings (NASDAQ: HA) has been having a terrific 2017. In the first half of the year, the company's net income surged more than 30% compared to the same period of 2016. For the second half of 2017, analysts expect Hawaiian Holdings' earnings to be roughly flat on a year-over-year basis.

You wouldn't know it from Hawaiian Holdings' 2017 stock performance, though. Hawaiian Holdings shares have lost about a third of their value this year.

Earlier this month, rumors that Southwest Airlines (NYSE: LUV) would soon announce service to Hawaii sparked the latest round of selling. This makes it a great time to buy Hawaiian Holdings stock.

Southwest is coming to Hawaii -- maybe

Southwest Airlines has seen Hawaii as an attractive growth market for a while. However, earlier this year, Southwest Airlines CEO Gary Kelly began to indicate that flights to Hawaii are now a high priority for the company.

Recently, it has seemed like an announcement could be imminent. Last week, Southwest Airlines was the lead sponsor for a tourism summit in Hawaii. Around the same time, the carrier decorated a gate at San Jose International Airport with Hawaiian-themed pineapples. There has also been an increasing amount of communication between Southwest Airlines employees, the Hawaii Tourism Authority, and Hawaii government officials.

Even so, nothing is set in stone until an official announcement is made and the first batch of flights are scheduled. At this point, it's relatively unlikely that Southwest will launch flights to Hawaii before mid-2018. (Indeed, it has already opened its flight schedule through June 1, 2018, and flights to Hawaii are nowhere to be found.)

Southwest Airlines' growth in Hawaii could be fairly slow

While Hawaii represents a significant growth opportunity for Southwest Airlines, it could take at least two or three years for it to become a major player there.

First, the carrier has meaningful aircraft availability constraints because of its decision to retire the last of its 737 Classic airplanes at the end of this month. As a result, the size of Southwest's fleet will fall from 735 aircraft at the end of June to 707 by year end. Even by the end of 2018, the carrier will only have 750 planes, based on its current plans. That doesn't leave room for much growth until 2019 and beyond.

Second, Hawaii isn't Southwest Airlines' only growth priority. The company wants to add more flights in Fort Lauderdale after opening a new international concourse there a few months ago. It's also continuing to build out its international route network in Houston. Meanwhile, Southwest continues to have ample room for highly profitable growth in the continental U.S.

Several sources have suggested that Southwest Airlines could enter the West Coast-Hawaii market next year with at least 10 daily roundtrips. While not impossible, that seems unlikely based on the company's aircraft availability and its other growth priorities.

Will Southwest Airlines be a disruptive force in Hawaii?

Notwithstanding historical evidence of the "Southwest Effect" -- a dramatic fall in airfares after Southwest's entry into a new market -- the carrier's arrival in Hawaii won't necessarily upend the market. For example, there is already intense competition on many West Coast-Hawaii routes, unlike many of the markets Southwest has disrupted in the past.

Additionally, Southwest Airlines won't have as much of a cost advantage for flights to Hawaii, as it has had for many other routes. A key source of Southwest's low cost structure is its ability to turn planes quickly (i.e., minimize the time between when a plane lands and when it takes off for its next flight). This matters a lot for short-haul flights. By contrast, saving 15 minutes at the gate will be less meaningful after a six-hour flight to Hawaii.

Hawaiian Airlines is well positioned to compete

A sharp increase in capacity between the West Coast and Hawaii would undoubtedly lead to unit revenue declines at Hawaiian Airlines in the short run. But in the long run, Southwest Airlines' entry into the West Coast-Hawaii market shouldn't hurt the company's profitability very much.

For one thing, flights from the West Coast only account for about half of Hawaiian's revenue. Inter-island flights, international flights, and flights to New York make up the remainder. In the long run, Hawaiian Airlines hopes to diversify further by adding more international flights (and perhaps also more nonstop flights to the East Coast). Along those lines, the carrier recently announced plans to add two more weekly flights to New Zealand.

Secondly, Hawaiian Airlines earns a revenue premium on all of its domestic routes. Thus, even if it can't quite match Southwest on costs, Hawaiian Airlines will likely generate much higher unit revenue on Hawaii flights. The availability of extra-legroom seats for purchase will be a particularly important differentiator in that regard.

Most importantly, Hawaiian Airlines is about to gain an important tool for reacting to market shifts: the A321neo. Starting in early 2018, Hawaiian will be able to fly to the West Coast with a plane that has two-thirds the capacity of its A330s but similar unit costs. This will help the company respond to changes in the supply demand balance and protect its profitability.

Hawaiian Holdings stock currently trades for less than seven times earnings. Clearly, many investors think the company's earnings are poised to crash. A more sober analysis of the threat from Southwest Airlines suggests that Hawaiian is still positioned for long-term success.

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Adam Levine-Weinberg owns shares of Hawaiian Holdings. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.