Chit Chat Stocks - Hawaiian Air (Ticker: HA) Not So Deep Dive

Episode Date: September 26, 2023

Hawaiian Holdings, Inc. (HA) is the parent company of Hawaiian Airlines, a prominent carrier serving travelers to and from Hawaii, although it faces challenges due to the cyclical nature of the airline industry and the unique geographical factors impacting its operations. At the end of the month, we will publish an Arch Capital episode that will cover the company: Adyen. Listen closely as Brett and Ryan go through the history, financials, and future prospects of HA. Enjoy the show! ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (1:43) Industry | (12:17) Management & Ownership | (19:47) Earnings | (25:02) Balance Sheet | (29:00) Valuation | (30:57) Our Analysis | (32:44) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chitchat Money. My name is Brett Schaefer. And as always, I'm joined by my co-host, Ryan Henderson, on our Not-So-Deep-Dive episodes,

which for any new listeners, any recurring listeners know it is a bit in jest, but we are going over the basics of a company after reading over it for a week. We're going to go over its ownership, financials, future growth opportunity, business model, future growth prospects, a little bit of the history. After listening to this episode, we hope you get a better perspective on the company. You can be either inspired to put on the watch list, be inspired to do more research further, be inspired to maybe buy some shares. I don't know. Probably not. Maybe do your own research first, but hopefully it helps along with that research process. And, you know, with some of them, you might discount them to the sidelines. And this

one today, I think it's different than a lot of the high quality companies we cover. It's going to be unique, potential deep value play, potential falling knife. I think throughout this episode, we're going to debate whether it's a falling knife or a potential deep value opportunity. And it is Hawaiian Holdings, otherwise known as Hawaiian Airlines. We'll probably just put hawaiian airlines in the title because that's much easier for people to understand so ryan let's get right into it what does hawaiian holdings or again hawaiian airlines as we'll probably reference it do yeah hawaiian holdings is technically speaking the parent company of hawaiian airlines they when they open the 10k they say hawaiian holdings soul is the sole owner

of hawaiian airlines and that's the only asset they own and so did you see their tagline to spread aloha right that's not bad i gotta say not bad but maybe a little i've seen worse maybe a little bit you know up there in the clouds for a airline but no pun intended but i kind of like that one like spreading aloha it's decent for their theme but i thought i kind of laughed because i was like well you're just flying people to the islands and back yeah yeah if we're going to talk about it but if they can really kind of differentiate differentiate their service in a way that's makes people want to fly with them to hawaii then you know maybe that spreading aloha motto might might be playing into that and that might actually help with the business but

um anyways so hawaiian airlines is the 11th largest u.s airline based on revenue passenger miles. They own 61 aircrafts. They recently sold like four and they're on track to buy a couple from Boeing. I believe it's 787s, but they haven't delivered yet. So right around 61 aircrafts right now. And they use those planes, as you might imagine, to conduct flights across 216 different routes. Most of those routes, the lion's share are from either mainland US to Hawaii, Hawaiian Island to Hawaiian Island, or international markets to Hawaii. Typically, those are a bunch of different Asian markets, a lot from Japan, some from the South Pacific, some from Australia, New Zealand, those markets as well. Sorry. But that's the basics of it.

passenger revenue, 89% of it comes from domestic flights, which just means US to Hawaii, or I believe that might even include island to island flights as well. Prior to COVID though, that number was just 74%. So there used to be a bigger, there was more international tourism to Hawaii prior to the COVID pandemic. A lot of that's coming from weakness in the Japanese market. There are a lot of Japanese tourists that come to Hawaii. If you've been to Hawaii, you might notice that. It's a big market for them to travel to the same way it is for a lot of West Coast Americans. And so there just hasn't, and we're going to talk about this a little bit later, but there hasn't quite been the rebound from travel from Japan that there has been from

the US. Anyways, I've got a little map with all the routes outlined here for anyone that wants to check out the newsletter. It's pretty difficult to see because there's so many different routes on one tiny map, but it'll show kind of all their different channels that they travel to. We talked about Ryanair a couple of weeks ago, and they were really trying to be the low-cost provider. They kind of had some unique characteristics about their business that really differentiated them from other airlines. Hawaiian really isn't that kind of an airline.

They are kind of standard, I would say, except that they fly primarily only to Hawaii, but they're not trying to be the low cost provider. They are on the more expensive side. Brett's going to talk about that in a second, but they're really trying to focus on that service aspect and building customer loyalty. They have more than 11.7 million Hawaiian miles members that account for 40% of all their passenger revenue. And they have card partnerships with lots of organizations as a way to encourage flying more with Hawaiian. I think this has been a really helpful kind of evolution for a lot of these airlines where these new card partnerships and building up the miles with certain airlines really has established that loyal flyer base.

And so that is kind of the bulk of the business, just the passengers to and from Hawaii to mainland and international markets. But they also have 12% of their revenue from flying cargo, and they have some loyalty revenue as well. There's some other ancillary ways they can earn money, but really it's from flying cargo. And they actually just struck a deal with Amazon. I don't think we're going to talk about it at any other point in this episode where it's capacity to fly cargo on behalf of Amazon. I think they're just conducting the flights.

It's a big TBD on what the economics of this are going to be like. And it's a bit confusing because they haven't started it up yet. So we don't have any financials, but they announced a partnership. They're going to be doing cargo for them with... So here's what's interesting about it. And people, if you're going to be interested in this stuff, definitely look through the exact numbers here. But I think for the podcast, it's not really relevant. amazon is going to i believe buy the planes lease them to hawaiian air but as a part of this deal they have warrants to buy hawaiian air stock i believe it's at about 14 a share so that could be helpful to support them as we'll talk about later the share price is much much

lower than that so amazon could be a decent partner here to give them some diversification but it's unclear whether it's going to be you know 10 of revenue two percent of revenue something like that and just to kind of go through the cost lines for an airline we're kind of new to studying airlines i'd say so i'm just giving the brass tacks in terms of what are the major costs for hawaiian and airlines in general biggest ones are wages and benefits that's pilots that's people working the front desk uh there's a whole bunch of different crew that they have to employ a lot of them are unionized there's the the pilots union is one I think there's a couple of other unions that they have to work with as well.

Second largest cost for them is fuel. Both those account for a little less than 30% of their overall cost. And then the third highest is aircraft rent and maintenance at about 12%, and then everything else. So depreciation, they pay a lot of agent commissions to online travel agencies for directing them customers. They pay the airport fees that we talked about with Ryanair, where airports charge airlines to store and land their planes at their facilities.

It's usually charged as a percentage of each ticket. So they'll say $17 for each passenger you have to pay to us. That gets put through to the customer. Those are all kind of below 10% of their overall cost. But in total, in 2022, Hawaiian Air spent about $2.9 billion in costs on just $2.6 billion in revenue. Obviously, that isn't going to be sustainable forever. It's an airline.

I mean, you really got to be – we're going to get to the balance sheet here in a little bit. Got a little over a billion in cash. They can't lose $300 million a year perpetually. But let's get to the history real quick. I believe Hawaiian behind – there's one other. It might be Delta. It might be United. They are the largest standing airline in –

Longest standing. Longest standing. Sorry. Longest standing domestic airline. They were founded in 1929, which was actually 30 years before Hawaii officially became the 50th US state. At the time, it was called the Inter-Island Airways and was actually a subsidiary of the Inter-Island Steam Navigation Company. I miss these old company names. They were so descriptive. It was very clear what they did. Yeah, exactly. And hey, we don't need any consultants there telling us what to do. What are you going to name your company? We're going to name them Hawaiian Air or the Inter-Island Steam Navigation Company. We don't need any consulting saying we're going to call this, what should we call it? Something with no vowels. Yeah, Rover. Yeah, but sorry, continue.

Yeah, but for the first, I'd say, 50 years of its existence, it really only flew island-to-island routes and never really expanded. But around the 80s, they were starting to see a lot of competition from other airlines for those inter-island routes. And so they decided in 1985 that they were going to expand outside. And their first route was somewhere to the South Pacific. And then that same year, they launched their very first route to mainland US, which was to Los Angeles. And that was really the first time they ended up being in competition with the big carriers. From there, they continued to add more and more routes across both mainland US and Asia Pacific.

However, they were kind of expanding these routes, new airline to some people. they weren't able to do this profitably so in 1993 for the first time they filed chapter 11 10 years later due to unsustainable union agreements they filed for bankruptcy again and reorganized so they've filed chapter 11 twice done reorganizations they're still around they've since emerged from bankruptcy bankruptcy protection and for the most part they've flown profitably. Since 2005, there's been some lumps here and there. It came down a little bit after the great financial crisis and then COVID hit. When COVID hit, they certainly weren't profitable. A lot of people were avoiding traveling specifically to the Hawaiian islands. And then

in particular, they didn't see that international recovery from Japan, which made up a decent chunk of their revenue. And then we're going to get into some of the stuff that's happened lately, But there's just been pain points across the business that are a little out of their control. They've had supplier issues where they haven't been able to get their aircrafts up and running. They're sitting idle waiting for certain engine parts. They ordered new planes from Boeing. Boeing has had supply chain troubles themselves. And so they're not able to ship out or deliver as many planes to Hawaiian Airlines. So they're not operating at full capacity for the aircraft fleet that they have, which is preventing them from getting to profitability. So that's the current hiccup. And I'll just context right now, this stock, if things go back to normal for them, this stock is very, very cheap.

It's almost getting priced as if it's going to go bankrupt is what it looks like. So we're looking at potentially sort of a turnaround story here. With that said, do you want to talk about the industry and competition? Because in this case, I think it's a huge part of the thesis. Yeah, the competition is very interesting for Hawaiian Air, which might be a bit of a red flag for a company that you want to own, right? You want the competition section to be quite boring, I think, when we cover this. But I want to reiterate, since Ryan mentioned it, I don't want to harp on it. But again, Japan is their second largest market, and they're the slowest

market to recover from COVID. So that's really been hurting them, but we'll see what happens over the next few quarters. And it's kind of interesting. We've also, we also own match group. It's the Japanese market. It's no longer because of COVID restrictions. From what I understand the there's no like government restrictions prohibiting people from returning to prior COVID habits. There hasn't been as much online dating in Japan. There isn't as much travel, leisure travel it seems like so we're it's we were kind of talking about this yesterday it's weird that they haven't seen the recovery that they were expecting yeah as opposed yeah it is strange i don't know what's going on there but hawaiian did say the management did say that this summer has

been much more promising so we'll see if they you know finally uh start getting back to normal but yeah let's take competition so they operate the three main routes inter-island domestic to island And for example, that would be like Los Angeles to Honolulu and then international to the islands, which would be like Tokyo to Honolulu. Then the domestic island market, they compete with a lot of the airlines. So there's the big four, Southwest, United, American Delta, and then Alaska Air. The largest competitor here is not the big four, though. It would be Alaska.

They have tons of flights from the West Coast of the United States to the Hawaiian Islands, probably every day from Seattle, from Portland, from San Francisco, from Los Angeles, from Phoenix, the list goes on. And then within the inter-island market, Hawaiian used to have a big advantage here versus people that were coming in and traveling within the islands because there was minimal competition.

However, a couple of years before the pandemic, Southwest, maybe I said flooded here. I don't know if they flooded the market, but they decided to enter the inter-island market with very cheap routes. I think the number is $39 that they're giving out for these inter-island flights, which again, they're very short,

but they're probably going lower here and then hawaiian has had to match that because when you know you're flying six hours from seattle to honolulu you might want some premium stuff but if you're flying 30 minutes from across the islands nothing really matters there that's probably southwest bread and butter that's if you listen to the ryanair episode i'd and you haven't i'd go back and listen to that they want the short routes because that's when you can really treat it like a bus almost and just go for cheap, low cost. And that'll work. People won't really care too much about that. And then internationally, I would say they have less competition as opposed to kind of the quote unquote partners. And if you look at the

newsletter chart, you have like Japan Air, you have a bunch of other ones, Qantas, stuff like that, that fly from all these places in partnership with Hawaiian. That's pretty common throughout the industry. Now, if we look at the Hawaiian tours market For the United States, it has recovered to pre-COVID levels and gone even above, so that's very healthy. But the international markets, such as Japan, have not yet. If you look, again, I'll have a chart in the newsletter. And then I'll also have charts of the flight maps for Southwest and Alaska, which basically just show, yeah, they all fly to the same place. And then lastly, from a competitive standpoint, they position themselves, Hawaiian does, as the premium airline for travel to and from the islands,

which we'll discuss maybe the viability of the strategy, the perks here later. For example, I looked it up before this episode, a flight over the holidays. So very expensive one in general, from Seattle to Honolulu, just using Seattle because that's where we live. It would cost $730 on Alaska. But basically the equivalent time, equivalent day is $930 on Hawaiian. So it's going to be more expensive, but they're going for that. okay we have the hawaiian theme we have all these extra perks we're going to treat you well

you know seems like it's working fairly well for them at least on the united states side of things yeah if you can't be the low-cost provider call yourself a premium brand i know it seems like that's the way they've gone i mean while there has been a lot of competition they're still flying a lot of passengers even if you look at it prior to covid they're flying a ton of passengers that 11.7 million frequent flyers or what do they call it hawaiian miles members probably helps provide sort of that consistent travel and we should mention they have a credit card very similar to all the other airlines yeah and then their their load factors which is the airline's term for occupancy on flights is pretty solid right now however they're operating that with fewer

aircrafts so my thought here is it's comparable to pre-covid but with but they're only operating at 70 capacity i think a lot of that weakness is coming from so i don't think there's as many flyers a lot of that's coming from the the lack of demand from japan yeah and let me look uh i'll give a number out for the listeners here so they're they we're going to separate out their other revenue which is like credit card stuff cargo and etc and there's there's a number they use called revenue revenue passenger miles and revenue passenger miles just means the total miles traveled for all their passengers so they have 300 people on a flight and they go 600 miles 300 times 600 and then multiply it by all the flights over a year and then we also have their operating

revenue which is all their passenger revenue for for you know or excuse me not total operating just the the segment is passenger revenue of their total operating revenue which is the majority of it so in 2018 if you look at their op their excuse me passenger revenue per revenue passenger mile which is basically saying how what the price is per mile of the flights per passenger it was about 15 cents and now today it is in 2022 it was about uh 15 cents plus six so if you got out three decimal places, it was 0.15, or excuse me, 0.151. Sorry, this is very confusing for the listeners. Getting a little hard to follow here, Brad. I know. And then in 2022, it was 0.156. So basically the same, very, very similar. So

again, here's the thing. Here's the big takeaway. In 2022, they were charging about the same as they were charging in 2018 on a per passenger per mile basis. And that's probably because all the things Ryan has talked about with their headwinds that they're facing. But their operating expenses per passenger mile went from about 0.147 in 2018 to 0.191. So much, much higher, which is why, again, they're facing those profitability headwinds. They need to, especially because of inflation, they need pricing to go up overall. And a lot of that is probably from fuel cost increases along with wages growing as well. Right, exactly, exactly.

So TBD, if they can do that, but that's one metric I think we would want to track. Now let's get back to the show. Management, ownership, Hawaiian Air CEO is Peter Ingram. He's been the CEO since 2018. He's been with the company since 2005. I would note here for smaller companies, I like to look a little bit closer

at exactly how much the board and executive teams are paid because it can be quite relevant. The board of directors for Hawaiian Air is 13 members strong, and they get paid around $200,000 a year. Total board pay is 2.5 million in 2018. Now, if you look at peak net income for the company, remember, they're unprofitable right now. Peak net income is about 300 million. So 2.5 million versus the peak of 300 million. Again, market cap today, just for reference, I don't think we've talked about it yet, is only 350 million or so. That is very relevant, $2.5 million a year. I would say maybe they should

think about lowering that, but I'm guessing they won't. Now, if we look at executive compensation, Ryan, something to add. And you're about to say it. That is not executives getting paid for their work. That is board members, 13 board members. You're telling me that you need 13? I kind of call bullshit on that. They don't need 13 board members. They don't need to pay each one of them $200,000 a year, it feels like wasted expenses at a time when they probably don't need them. Yep. And you'll be shocked to hear they have compensation consultants. So what they're exactly doing on the board of directors, I'm not sure. But if you look at executive compensation, the metrics have got changed quite a bit. They actually have a nice table that

outlines it, but makes it tough to track. It makes it tough to track what their incentives are as executives and what they're going for because if it changes all the time you're like okay well what are the key kpis here what do we got to look for what are you looking for how is this business going to get to profitability and then second here in 2022 this is a big one that i caught annual comp uh metric was changed from ebitda to cash flow so there are excuse me to ebitda from cash flow so not good uh it and that's just for their annual bonuses and then third their long-term rewards are based on EBITDA targets, total shareholder returns, and then quote-unquote strategic goals, which not the best because a lot of it was just ESG stuff. Then last year,

I would say the note here, this is the biggest negative I saw. They got paid bonuses for generating negative adjusted EBITDA. That was in their ranges. So, not my favorite. That's horrible. Yeah, you could say like, yeah, it's a tough year, but look, let's not get paid for generating no profits. This is like, okay, so we're seeing all this stuff about the United Auto Workers Union right now fighting with the big three producers in GM, Ford, and Stellantis. And Mary Barra, the CEO of GM, got paid $30 million last year.

And then she said, well, it's out of my control. It's performance-based. if the stock hasn't gone if the performance is bad and you're hitting your performance hurdles that is a problem and it seems like that's a very clear example let me pull it up hopefully yeah okay hawaiian here let's look at the price here and we'll look at the total drawdown so do you want to guess how far hawaiian holdings the stock we're looking at today, is off its highs. All-time high. 70%.

88.5%. And they are hitting their performance goals. I know. I know. Yeah, exactly. Now, if we go to the ownership table, it is quite interesting here. This is one of the most unique ones I've seen. So people may have seen that Jets ETF, they got very trendy during the pandemic. People wanted to use it for the airline recovery. It became a bit meme-y. They own an estimated 13% of the stock and its AUM from what I checked is going down. So that could be, I wouldn't be surprised if the flows from that ETF have effect on the stock price because 13%, you know, things can change pretty rapidly with these ETF

traders. That's kind of crazy. And again, the other ones are BlackRock, 18.5%, Vanguard, 8.8%. And then we'll go to the CEO, decent amount here. I think this is kind of a positive. We have a, it was a bit of a negative proxy statement, but kind of a positive here. He owns 0.66% of the stock with where the stock is trading. That's actually not that much money compared to a lot of the other CEOs we've seen. But I think that's positive because if he turns this thing around, I think he could be making 10, $20 million here out of his stake.

Yeah. I'm just kind of backing into the math in my head there. That's like $20 million. worth of stock that he owns uh no one percent no no no because it's the market cap is 350 million oh sorry two not eb it'd be like two million dollars yeah that's what i mean so it's like not that much if things go well though he is positioned to make a ton of money so certainly feels incentivized to do well um let's let's go through the earnings it's a little difficult right now i think it's probably more important to talk about the trends

and what the management team and Hawaiian Airlines overall is seeing as opposed to the specific numbers, but I'll talk about some of them. So in the most recent quarter, passenger revenue grew by 4.5%. That is the lion's share of their revenue. So that's really, revenue is going to basically follow that unless this Amazon deal does exceptionally well or something like that. They still reported negative 2% earnings before tax margins, which I really think is probably the useful metric for them here because they've got some interest expense on the balance sheet.

Their load factor, which is total revenue passenger miles divided by available seat miles. So fancy word for occupancy was 86.7% that has improved. Keep in mind, I believe it's kind of peak season right now, given that it's summer and they talked about having really strong load factors in certain markets. That is generally in line with what they were doing in 2019, Q2 2019. However, in Q2 2019, they had more aircrafts. They were operating their full fleet. Today, they aren't able to operate the fleet because of some of those supplier constraints that we mentioned. So they're generating similar load factors on a lower amount of planes or fewer planes. So still not fully recovered, it seems like. One of their biggest costs right now is

exactly what I just talked about. They're just having those planes sit idle. They're getting, I think they call it, I can't remember, credits from Pratt & Whitney, which is their supplier, which is basically just some compensation to offset the fact that they're not able to fly the planes right now. It's helping, but it's certainly not enough. So I should have mentioned this too they have three different aircraft types there's airbus a321s it's another airbus uh they probably have a small one but most of them are the big ones right and then they're transitioning to the 787 but a lot of them are going to be the dual the dual aisle because most of these are six hour plus flights but then the inter-island they're going to be the tiny ones

right so they've had three of their 18 a321s sitting out of service because they needed that engine change from Pratt & Whitney. Now, basically there's a whole bunch of struggles right now that are preventing them from getting to profitability. So I wanted to use this as a reference. It does not mean they're going to get back to it, but I think it's worth looking at what were operating margins like prior to COVID. So from 2014 to 2019, operating margins ranged from 6% to as high as 23%. On average, it was probably more 10% to 15% range. So if there's a chance of them recovering and getting back to that 10% to 15% operating margin range, they would be generating pretty much their entire market cap in earnings in a single year, assuming that, like I said,

can get back to that figure but yeah and if you look at the chart i think you can guess around what time southwest started to compete with them yeah yeah yeah that and that's one of the other concerns is how much of this is caused by issues with suppliers versus how much of this is caused by competition which is a bigger issue yeah and then there's fuel which is ryan mentioned big costs. They're very volatile. There's also, which I feel like so many companies we will look at, they're international, just get affected by this. The deterioration of the Japanese yen versus the US dollar that makes it extremely expensive for a lot of Japanese middle-class people to fly to Hawaii. So many factors here, which we'll talk about, but yeah, you want to hit balance sheet.

Yeah. And the balance sheet was in general, pretty big positive. If you were looking at Hawaiian and you didn't see the balance sheet, you'd think, man, I'm probably not going to touch this. But because it's given them a little bit of liquidity and time, it's bought them some time, I think it's certainly a positive. So they have $1.3 billion in cash and short-term investments. They're earning a lot of interest on that. Most of that is in short-term investments. And they have $1.6 billion in long-term debt, $1.7 billion if you include finance leases. So let's call it 1.7. The bulk of that, 80% of that debt is what they call loyalty program financing. I think the collateral is the loyalty program, right? I believe it was very unique.

But again, I don't know. I'm no expert on debt structure. Yeah. I wasn't sure exactly what this was financing for, to be honest, but I looked just at the terms of it and it's a fixed interest rate of 5.75%. So reasonable. they're earning a little less than that, probably with their treasuries right now. And their quarterly payments are only the interest. So the $1.2 billion, which is the principal, that $1.2 billion loan isn't due until the first quarter of 2026. So they only have $70 million in debt due over the next two years. That's good because they got a lot of CapEx, as we'll talk about with the 787s, the cargo, starting up a lot of stuff. Yeah.

So if they're able to solve some of their short-term issues, calling it short-term, in the next two years, they're going to be in a good position to pay down some of that debt. And really, they bought themselves some time, like I mentioned earlier. So very manageable balance sheet, especially if they can get back to positive operating margins. I'd call it $400 million in net debt. So tack that onto the market cap for any valuation work you're doing, which leads right into, Brett, valuation. Yep. i did use 400 million here if we look at them again they're not profitable right now so i just did a couple of estimates and yeah we look at their market cap about 360 billion we add that

up enterprise value about 759 million i think i might have said billion but it's million this is a small cap and then what i did here is just made two assumptions one that the international revenue is going to recover. I'm just assuming it does. And over, let's say, the last 12 months, it had recovered. And I think in that scenario, given where inflation was or is, we'd probably hit about $3 billion in total revenue. Now, the assumptions I made were basically what their net income margin could be, or maybe we'll just use pre-tax. It doesn't really matter too much. And I said they could be at 4%, 6%, 8%, or 10%. And remember, 10% is kind of what they were pre-COVID, but I think we want to be conservative and think,

man, that might be a ceiling here given all the headwinds they're facing. And if we go at 4%, they'd be earning $120 million each year. If we go to 10%, they'd be earning $300 million. If they hit 4% margin at today's enterprise value, they'd be at an EV to earnings of 6.3. And if they hit a 10% margin, they'd be at an EV to earnings of 2.5. A lot of numbers, but I think the summation there from looking at this is if they can get the operating leverage back, the stock is very cheap. So I think if you're looking at this thing, the question is, can they get back to profitability? And I think that leads to kind of the closing segments we do to try to figure that out as best we can. So first up, Antidote

evidence. Ryan, any here? I know they fly a lot from the airports we use on the West Coast. Yeah. I've maybe used them probably more so as a kid. Nowadays, I typically just default to Alaska Airlines to rack up the miles because I'm a miles member there and I have the most miles with them. And they're typically a lower cost provider. So I typically just go with them, which- Do you have the Alaska card? Did you get that yet? I don't, but my parents do. And I would say the most out of the times I've been to Hawaii, the majority have been you know with my parents so the uh it's it's maybe i should be at the alaska card the i say that because or i talk about the alaska part not as kind of this throw it to

the side anecdotal evidence but that is a real threat here you've got these big carriers that have big membership programs big card holders called cardholder bases that are now getting into the same flights or have been getting into the same flights as Hawaiian. And I think they're really starting to carve into that kind of competitive or those same routes, that same customer base. It's starting to, I don't know, they're starting to eat away, I guess, at Hawaiian's market share. Yeah. And Hawaiian has 11.7 million members, but again, it is competitive. They're all doing very similar things. And for people that live on the West Coast that also go to Hawaii, like, okay, do you want the Alaska card? Do you want the Hawaiian card? Do you want both? I guess

they're probably fairly cheap if you go to hawaii a lot maybe the hawaiian one is for you it's tough to tell maybe alaska should just buy hawaii and i think that's my big conclusion here i think they should honestly it's on that call there might that might be antitrust concerns for for that but what uh okay what's your title yeah so i think the premium airline is a bit of a conundrum like on the one hand for a longer flight to hawaii which a lot you know that's a lot of their flights, right? It's a lot where their money's made. I think I would pay up a bit for good seats, free food, free good Wi-Fi, which they're going to get. They have a Starlink partnership here. On the other hand, I don't know how much I would pay up for, right? Where

if we had that one of the $930 versus the $730, maybe I'd go $930, right? If I knew that there was a lot more perks and it would be a much comfortable flight, but it really depends how long the flight is you know there's a lot of factors there and honestly i i don't know how many people kind of treat it that way but they are trying to even go even more premium here they're launching new stuff on the 787s that they're getting that should be even much better so we'll see if they can get that um what's the metric i called it so confusing revenue per revenue passenger miles so basically the price per mile that they're charging customers All right. And I don't know. I haven't been to Hawaii very much, I think. So I've never flown before. But future growth opportunities. Ryan, what do you think?

Yeah, this one is not really in their control, but getting back to full capacity, right now it's the difference between them being profitable or not. And so it's the biggest holdup and it's what investors are most concerned about. If they're not able to operate their full fleet, they're not going to be able to be profitable. They're not going to be able to generate as much revenue as they would flying more routes. So they said it's going to take at least two quarters, I believe was the word they used, which is corporate speak for a year. And I worry that this is coming at a time when leisure demand is pretty strong. If leisure demand starts to abate and there's some weakness there while they're still having the capacity constraints, what's going to happen to profits? i'd say the u.s market is not they're not like they're operating very like that they're they're

to mess their u.s to island routes are doing extremely well right now i think those routes are probably profitable the big question is japan and the yen is going down even more so i we'll see yeah uh yeah my i mean that leads into my future growth opportunity which is the return of japanese travelers i would think eventually they have to come out of their caves right like it's been the slowest country here in hawaii's regions uh to get back to international travel it's really brought down their international revenue which you can see i'll have a chart up there too about japanese tourism to the hawaiian islands and it's much much lower than pre-pandemic but the u.s tourism traffic is higher so again uh but they have said they've seen some green shoots summer growth was

pretty strong coming out of japan but on the other hand the yen is weakening again which makes traveling to hawaii very expensive so i don't know how much is a foreign exchange bet here but it is a bit and i mean if the end keeps going down like man like aircraft prices are going to be expensive because fuel prices are you know based in dollars so it makes it double more expensive especially fuel prices are going up yeah all right that makes sense right you like fuel prices are going up in us dollars but it's even more expensive if the yen versus the dollar is deteriorating okay highlights and lowlights brian what do you like what do you dislike about this business they've got a big frequent flyer base i like that it brings people back to them consistently and then you showed the

chart but tourism to hawaii continues to grow especially from u.s mainland which even if they lose some share to Alaska and Southwest and maybe Delta as well. I don't know if they fly those flights, maybe East Coast to Hawaii, they do. They can still grow the passenger volumes without necessarily growing share as long as the tourism remains strong and tourism to Hawaii continues to grow. And that's been a big tailwind for them over the years. The last thing, last highlight for me is they have a good balance sheet and they've demonstrated that they can be profitable. Maybe they won't be as profitable as they were in 2017 but they can be profitable if things are going well the difficulty is like michael ho what's it is michael o'leary the guy the ryanair ceo he said

the airline industry is always three to four years away from the next crisis yeah it's just a dramatic way of saying it's a cyclical industry but he says it very eloquently I just constantly think like, we're talking about trying to normalize margins and trying to get to, okay, what does steady state margins look like? Well, it's always going to be lumpy. That's what it seems to be. Low lights for me is pretty much just that. There's tons of moving parts that are generally out of their control. We're seeing that right now with Pratt & Whitney engine delays, the Boeing 787 delays. They had issues the first time they filed Chapter 11 with the union agreements. They have so many stakeholders involved in the process that it's hard to manage an airline, and it's hyper-competitive. So that's kind of my second low light. And then the third one is they're struggling to be profitable at a time when leisure demand from the U.S. is rock solid.

But if anything happens, while there's these capacity constraints, what happens then? Yeah, yeah. And I would say, I don't know if investors should be really concerned about Delta and stuff like that as, yeah, they fly these routes. But I think the concern really from a competitive standpoint is to watch Southwest and Alaska. Those are probably the two big ones. Yeah, like, okay, Delta might have a route from New York to Hawaii, but that's going to cost them a lot of money anyways. And I think people are going to trend towards the Hawaiian

air there. Now, my highlights are that they are the well-known brand in the space. If you're going to try associate traveling with two and from Hawaii, Alaska is pretty good as well. But Hawaiian, given that her name, I think people associate much better. They have the theme, you know, with doing all the stuff on the flight to get you ready to, you know, get to the island, stuff like that, embracing Aloha. They actually are, from what I've read, very good at that. I'll have a link to a blog post that basically says like, okay, what are the best? It has the list of the six flights that fly from the U.S. mainland to Hawaii. And their number one was Hawaiian, unless you're very, very worried about cost.

So I like that. And I think that should give them a bit of pricing power. But again, they're going to have to price a little bit higher here. They're going to get to profitability. Second one is the growth of the credit card program and the freight revenue from Amazon should diversify the business away a bit from the cyclical commercial air travel market. But again, it's not going to be a huge part here. Maybe TBD on the cargo stuff. But I like it. I like that deal. I think it hopefully was a bit of a, how do I say it? Lifeline? Maybe not a lifeline,

but they might've been a little bit desperate signing that deal, but I think it can do well for them. And then second or third highlight is the cash balance. Over a billion dollars in cash should give them a lot of ability to operate for the next few years as ryan mentioned the debt is not due right away so we'll see on that but like there's runway i think here for them to try to figure things out over a multiple year period low lights i mean the big one for both of us has been the sickle nature of this industry pretty choppy cash flow and then the second one let me just add up all the headwinds they're facing right now so you have pratt engines uh that are leaving the planes grounded that ryan mentioned you have the 787s that are being

slow from boeing i think just to go on that even further the the reason the 787s are so important for hawaiian is that it's going to allow them to one be more efficient and two upgrade to more premium stuff for their seats because that's just how these planes are built so they're going to have these live flat uh very expensive first class cabins i think that's going to hopefully help them with their that you know price per mile stuff but again if boeing can't get it to them well that's going to be delayed time and time again uh there's competition from southwest on inter island routes there's foreign exchange make it harder for international travel there's the hawaiian fires or the big fire i guess tbd how much that's going to affect things maybe it's not as bad but

we'll see they haven't really had an announcement on its impact i think it'll be obviously it was a terrible tragedy, but I think it'll be okay for them. Then fuel prices going up, right? That's a huge unknown. They're going up again this summer or as late summer. So all of these, you add them back together, it's going to be major headwinds for them to getting to positive profits, which definitely worries me. Okay. Let's close things out. Bull case, Ryan, what do you think here? Well, I think the bull case, there's big upside if things get back to normal. So If leisure demand stays strong, the delays dissipate from both Boeing, Pratt & Whitney, and fuel costs stay relatively flat, maybe even they go down, I think they can get back to that

5%, 10% operating margins. Let's be optimistic, say that they actually do that. They'd be generating probably around 30% of their enterprise value in cash each year. That's a lot to buy back stock. I think you could probably get a three or four bagger in a matter of a couple of years. Yeah, for sure. And they can pay down the debt. I mean, the debt would go be no trouble there. And if they pay it down, I'm sure the stock would probably go up as well. Yeah, I mean, it's the same one here.

It's just that it's basically just for me, the bull case is that the headwinds go away. Like if they get some of these 787s back up, they could really flip that from being operating expenses being higher than revenue to flipping that to positive there. I mean, they've talked about having free Starlink Wi-Fi on these things. they've talked about having these ultra premium classes that you can lie flat on a bed or basically it goes back to 180 degrees so you know that seems very nice for these things but again how many people are going to pay for them we'll see you know international market is maybe back from japan fuel prices stop going up which again that one's i would say what as anyone that tries to

predict that i think it's insane um if they do all this stuff revenue per seat mile compared to operating expenses could get back on the right track. We could flip that and get back to how it was pre-COVID where they were above there. But this is probably a late 2024 into 2025 timeline. So I don't know in the interim, the next few quarters, it seems like they're telegraphing that it's going to be very tough, which probably leads to our bear case. Ryan, what is yours? Yeah. Let's say it takes a year, maybe even two to get back to full capacity. And in the meantime, leisure demand worsens, if that happens, or fuel costs go up as well, if they start losing a lot more money than they're currently losing, because right now they're in this middle ground

where the leisure demand environment is pretty good, at least from the US mainland, which accounts for the majority of their passengers, but they're having the supply constraints. If both things worsen, there's a path to bankruptcy here, especially if it lasts, I don't know, a couple of years, then they've got a real big problem on their hands. Yeah, and it's not immediate, but could be- No, that balance should buy some time. Yeah, it could probably be a three, four-year time horizon. And again, if people are looking at this and say, oh, they won't go bankrupt again, look at the history Ryan mentioned. They've gone bankrupt for what, twice, right, since 1990?

Twice, yeah. it's not out of the realm of possibility yeah it's the same one to me like they can never really get back to those pre-covid numbers and they're really bogged down by the cost conscious more scaled players specifically southwest and alaska and then with they have all these variabilities on cost so it's a big unknown okay the bear case is the numbers don't really pencil out and a lot of that stuff's out of their control now as we this is a bit of a conundrum of stock and i think we have mixed feelings here so i'm curious ryan what are your final thoughts more or less interested in hawaiian holdings yeah i don't know because you can clearly see the

upside of things get back to any sort of level of normal but the difficulty is it feels like whenever i've looked at an airline i constantly say the same thing if things get back to normal if some of these headwinds abate there's always headwinds and they're always it seems like every time i look at them it's hurting margins these like short-term headwinds are hurting margins it i don't know that i worry about i'm i'm a little reluctant to buy any airline and i'm not sure i want to buy the one where it feels like bankruptcy is a very real possibility yeah and look i we did mention that the best opportunity here might just be alaska buying them out i'm looking here and it's not it's a this is an aggregator it looks like alaska has

2.44 billion dollars in cash so they could easily buy out hawaiian for a decent premium there so i think that is a decent and positive as they could get bought out i'm more interested i think you know ryan's question there if if there's a chance of going bankrupt well okay if the upside is high enough you can take the risk obviously sizing it correctly and yeah that might not be for everyone i don't know if it's for me it might be too risky for my taste but i think you can there is a reasonable thesis where the risk reward makes sense. If you think there's a chance to get five, 10 bag over a few year period, yeah, you can size it very smallly. And if it goes bankrupt, well, it's just like, okay, is there a 20, 30% chance it goes bankrupt? But there's a,

their other outcome is that they go up by five, 10 times. I don't know if that's a bad bet to make, but again this is one i think clearly you don't size very aggressively if you're going to do it i mean it's extremely risky yeah i agree all right let's talk for next week what do we have yeah so we're closing out the third quarter and we're going to be covering ad yen it's not a part of the theme we're just doing kind of our arch capital fund episodes where we do basically something that we're looking at i think it's a perfect timing here because ad yen has gone down quite a bit and the story maybe has changed so we're going to do an update there it's going to be a very fun one and then we're going to be updating takes oh it seems to have takes on

now i know i think that i'm glad this is the doing timing here just from our listener perspective hopefully it'll give us a nice little boost but as well we are going to be deciding our monthly themes for the fourth quarter so october november and december if you have any anything you want us to cover from a sector industry any sort of theme let us know we haven't decided yet but we'll be deciding that within the next week hopefully get it out to everyone and talk about it on the episode that's going to do it let's give out the disclosure we are not financial advisors anything we say on this show is not formal advice or recommendation we are general partners at arch capital and clients may hold securities discussed

in this podcast thank you everyone for tuning in and we'll see you next time We'll be right back.