MIAMI — Hawaiian Airlines announced that it lost $5.1 million in the first quarter of 2014, or $0.10 per diluted share, on Tuesday afternoon. The loss was blamed on the weak winter travel season, while executives countered by pointing to good cost control and strong domestic route performance that enabled the carrier to avoid a repeat of Q1 2013’s $11.9 million loss. Exchange rates, particularly in Asia, also continued to plague international performance. The carrier recorded an adjusted net loss of $0.9 million ($0.02 / diluted share) taking into account “economic fuel expense”

Despite the loss, operating revenues were up 6.9% year over year (YOY) from Q1 2013, to $524 million. Passenger revenues grew 6.4% YOY, while other operating revenues grew 11.3%, thanks in part to the new co-branded credit card relationship with Barclays (upgrading from Bank of Hawaii). Passenger revenue per available seat mile (PRASM) rose 4.4% YOY to 11.60 cents on a 1.9% increase in capacity as measured by available seat miles (ASMs). Yields rose 5.7% to 14.50 cents on a 0.7% increase in revenue passenger miles, which also yielded a 0.9 percentage point decline in passenger load factor.

The increase in capacity came despite the slowdown of economic growth and sagging leisure travel demand in Asia (China excluded), which represents an increasing share of Hawaiian’s overall capacity. During the quarter, Hawaiian Airlines launched new thrice weekly services between its Honolulu hub and Beijing, and added a fourth weekly flight to Brisbane, which accounted for the majority of the capacity increase. While the launch of Ohana by Hawaiian into Lana’i and Moloka’i represents a significant number of seats, its extremely short stage length reduces its impact on overall ASM growth.

Turning to region specific results, North America generated $219.95 million in operating revenues with PRASM up 11.3% YOY despite a 1.6 percentage point decrease in load factor (and industry capacity to Hawaii declining by 0.5% YOY). Inter-island routes generated $117.01 million in operating revenues with PRASM growth of 8.5% YOY against a 0.7% decline in load factor. Hawaiian Airlines’ inter-island operations are also due for a boost thanks to the shutdown of Mesa’s go! operation at the beginning of April, which had competed with Hawaiian on key interisland routes since 2006. Ohana by Hawaiian currently represents less than 5% of total neighbor island capacity, but still serves as an important network portfolio booster. International routes (to Asia and the South Pacific) generated $131.04 million in revenues during the quarter, though PRASM decreased sharply by 7.1%.

Hawaiian blamed the Asia-Pacific PRASM decrease on “a number of new routes still in their infancy.” And while there is some merit to the “infancy” categorization, the majority of Hawaiian’s Asia-Pacific route network has been in service for more than a year, and to continue to claim a lack of maturity on some of these routes seems rather disingenuous.

Currency effects certainly played a role in PRASM decline (totaling $9 million net of hedges), as did increased competition from foreign carriers such as Jetstar Airways, China Eastern, and others. But these factors are in many ways independent of a route’s “maturity,” so the continued underperformance of the international network remains troubling. That said, it is heartening to see that Hawaiian Airlines is finally willing to pull the trigger and axe underperforming international routes. During the first quarter, it announced the cancellation of thrice weekly services to Taipei and Fukuoka, both of which suffer from severe competition.

Looking forward, Asian economies are in a weakening phase as emerging market economies around the world struggle with structural problems. Japan was thought to be a bright spot amidst a sea of relatively poor macroeconomic fundamentals in Asia, but the recently implemented sales tax increase is likely to reduce consumer demand for leisure air travel. And the likely Abenomics solution to the increased sales tax, further monetary stimulus, will only serve to put Hawaiian Airlines under further currency pressure.Throughout the rest of this year,

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Hawaiian Airlines had hedged 59%, 54%, and 41% of its projected foreign denominated Japanese Yen sales at a weighted average forward contract price of roughly ¥100 per US dollar, which means that if the value of the yen dips below ¥100 per dollar, Hawaiian will still be able to convert a certain percentage of its Yen to Dollars at an average price of ¥100 / dollar. Abenomics may have been great for kickstarting economic activity and staving off deflation in Japan. Not so much for Hawaiian Airlines’ Japanese network.

Operating expenses increased 2.4% YOY to $514 .82 million. Decreases in per-gallon fuel costs, which were down 4.3% YOY to $3.10, combined with efficiencies gained from its growing Airbus A330 fleet enabled a decrease in fuel costs of 1.9% YOY to $171.14 million. Wages and benefits, maintenance, and depreciation all rose against 2013, however, at 4.6%, 5.5%, and 19.3% respectively. Operating cost per available seat mile (CASM) rose less than 0.6% YOY to 12.75 cents, though excluding fuel rose 2.8% YOY to 8.51 cents. According to Hawaiian, 2.6 percentage points worth of that 2.8% YOY increase in CASM ex. fuel, or $9 million was due to several projects in one-off items.

Hawaiian ended the quarter with $479 million in unrestricted cash, cash equivalents, and short term investments (versus $438 million at the end of Q1 2013), as well as a $69.5 million revolving credit facility for additional liquidity. Hawaiian has outstanding debt and capital lease obligations of $940 million. During the quarter, capital expenditure totaled $170 million in payments for upcoming aircraft and engine deliveries, while an additional $3 million was contributed to a post-retirement plan for employees.

Despite suffering a net loss, Hawaiian managed an anemic operating profit of $10.04 million versus an operating loss of $11.93 million during the same time last year. This translates to an operating margin of 1.9%, which is decent, though certainly not industry leading.

Hawaiian Airlines issued guidance for its operating statistics for the second quarter and full year, projecting CASM ex. fuel to be up 4 – 7% in Q2 and 2 – 5% for the full year. Capacity growth for Q2 is projected to be 0.5 – 2.5%, while full year capacity growth is projected at 1 – 4%. Q2 PRASM is projected to be up 3 to 6%, while Operating RASM is projected to be up 4.5% – 7.5% thanks to superior ancillary revenue generation amongst other factors.

Looking forward, Hawaiian’s muddled results are a good facsimile for what will likely be a choppy earnings season for US carriers, though for slightly different reasons (Hawaiian was not affected by the polar vortex). In a more general sense, it is interesting to consider the question of Hawaiian’s growth strategy. On the one hand, you have CEO Mark Dunkerley’s optimistic vision, which he outlined specifically with regards to China on this quarter’s analyst call:

The market is of such massive potential, it almost defies our ability to calculate it. It is a market which if you take by comparison the number, there are roughly today I believe something in the order of 18 daily flights from Japan to Honolulu. That is on a obviously wealthy country with about 150 million in habitants. There are already about 150 million all China’s over 1 billion citizens who have roughly the same level of wealth as the Japanese average. So that alone without even sort of stretching gets you from a place where today there are 9 flights a week to an environment where you could foresee 20 or more flights a day into sort of Hawaii. So, the real issue is that it is a developing market in the sense that foreign travel, patterns of travel, the distribution system in China are not as well-worn and solid as they are in other markets. But as that process come at jolts, there is essentially almost no limit to the amount of demand that China could spur for travel to Hawaii.

– Credit: SeekingAlpha.com

This type of limitless growth potential is what Hawaiian Airlines is betting on. And it’s a compelling growth vision, one that has sucked in more than one outside observer (mostly in the fringe investment community). But there are a few problems with that scenario. The first is that dynamism is a double-edged sword. Asia’s air travel market is fast growing, but that also makes it fast-evolving. Asia-Pacific has become a laboratory of sorts where myriad business models are all making money (as opposed to the extreme stratification in the US), and lower cost long haul travel is being attempted full scale.

Even if low-cost long haul does not pan out, Asian carriers have and will continue to have lower CASM than Hawaiian Airlines. So all of this growing demand is offset to some degree by the ability of the competition to more profitably capture a larger share of the market. Moreover, comments by Hawaiian Air executives on the earnings call about the lower than expected market stimulation of their new service in Taipei (25% versus a projected 50%), along with the failure of their Fukuoka route (albeit under pressure from direct Delta competition)  make me question if Hawaiian Airlines has largely tapped the Asian market that can be tapped for the foreseeable future, at least within the range of the A330-200. This is perhaps, the single most important question for Hawaiian Airlines to address in the coming months.

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