BUY SHORT Price: $5.68 Target: $8.00 Price:$6.04 Target: $4.20 valuehuntr@gmail.com
Overview Highest ranked carrier in performance and quality Best safety record (never had a fatal accident in 80 years of operation) High customer loyalty Aggressively expanding capacity (Japan, South Korea) Lowest valuation in industry Efficient aircraft fleet One of worst operational records in industry (recent FAA fine) Highest industry costs Oldest aircraft fleet in industry, including inefficient MD-80s Over-diversified fleet Significantly underfunded pension plan Highest valuation in industry Regional carriers are better positioned for value creation than US legacy airlines
Load Factors 86% 81%
% Total Arrivals on Time 94% 81%
Lost Baggage per 1,000 Passengers 1.9 4.3
% Monthly Flights Cancelled 0.2 1.3
Competitive Landscape Hawaiian Airlines Aloha Airlines: filed for Ch 11 bankruptcy in 2006, ceased operations in 2008 ATA Airlines: ceased operations in 2008. Hawaii Superferry: filed Ch 11 bankruptcy, ceased operations in 2009 Mesa Airlines: filed for bankruptcy in early 2010. Currently undergoing restructuring (still operating inter-island service under Go! Brand) Inter-island transportation share: 85% Fleet commonality less inventory, less maintenance, less training Key geographic advantage no inter-island driving, no ferries, no rail)
Competitive Landscape American Airlines Never filed for bankruptcy has therefore racked up $10 billion in losses for past 10 years Competing directly with newly-restructured companies (Delta/Northwest and United/Continental AA at competitive disadvantage Labor cost disadvantage at $600M vs. Delta and Continental One of oldest and most diversified fleets in industry MD-80 fleet poses significant safety and operational risks
Aircraft Fleet Commonality 3 10
Aircraft Fleet Age MD-80s are 44% of AA s total seating capacity
Pension Accounting Pension Expenses unrealistically low: Pension expense increases as the expected rate of return on plan assets decreases HA: Lowering the expected long-term rate of return on plan assets by 1% would increase the estimated 2010 pension and other postretirement benefit expense by $2.0 million AA: Lowering the expected long-term rate of return on plan assets by 1% would increase estimated 2010 pension expense by approximately $70 million
HA Fuel Sensitivity Case Scenarios Worst Case 2011 EPS: $0.44 Earnings Yield ~ 9% Base Case 2011 EPS: $0.64 Earnings Yield ~ 13% Best Case 2011 EPS: $0.78 Earnings Yield ~ 16% Consensus EPS: $0.68
Fuel Prices (Worst Case) American Airlines is more exposed to fuel price fluctuations than Hawaiian Airlines
Valuation American Airlines is more than 2X more expensive than Hawaiian Airlines
Risk/Reward Profiles (Best/Worst Case Scenarios)
Key Catalysts Addition of Honolulu-Seoul route (Jan 2011) Addition of Honolulu-Tokyo route (expected to be profitable within 3 months of opening vs. 18-24 months for comparable routes) Increased leisure traffic to Hawaii as economy improves $10 million stock buy-back (4% of shares) Our shares are trading well, well, well below the implicit value of our equity and we think it is the best use of the Company's cash at this time (Mark Dunkerley, CEO) Excessive capital expenditures due to MD-80 replacements Increased safety concerns due to aging MD-80 fleet (FAA $20 million fine) Transport Workers Union recently rejected labor deal. Vote also authorized a strike and release from the mediation board. If release is granted, workers could call for a strike (see appendix)
APPENDIX
Why Is HA so cheap? (Key Risks) Price War: prices have been crushed by Go! Mukuleleinter-islands routes. This is possible because Republic Airways (90% owner) is subsidizing the low-fares for Go! Mokulele, which means HA has a competitor that can price below market for the indefinite future. Counter Arguments: - Prices have stabilized -Capacity expansion to Korea and Japan will drive future growth (Japan is Hawaii s largest source of international visitors and capacity is down 25% due to JAL restructuring) -HA has more a more competitive schedule (departs California 8am vs. mid-day and departs Hawaii 1:30pm vs. night for competitors) -With equally low prices at both airlines, customer service and quality becomes more important key HA advantage (aircraft noise, food, OTA, etc.) New Entrants: Alaska Airlines and Allegiant entering Hawaii will further drive down prices Counter Arguments: -Capacity expansion to Korea and Japan may offset loses due to potentially escalating price war -May not be able to compete as prices are so low already (per ATA, Mesa)
Why Is AMR so expensive? (Key Risks) Pension worries: not built into stock price Merger Speculation: hope due to possible merger with US Airways Counter Argument:-Merger synergies would not be enough to compete with Delta/Northwest and United/Continental, which would still be better capitalized and have much larger networks -Unlikely US Airways shareholders would approve a merger with worst airline in industry More Fuel Efficient Planes: replacing MD-80s with 737 will lead to lower fuel costs Counter Argument: -Even after accounting for fuel savings, AA would not be profitable. On a relative basis, Hawaiian Airlines would still be less sensitive to fuel prices. -By replacing its fleet of MD-80s now, it may miss out on a new generation of fuel-efficient airplanes coming down the line
Hawaiian Routes Interisland Transpacific International
ROIC Value Creation Value Destruction
Comparative Valuation Source: Imperial Capital Report (8/5/10)
Street Estimates
Hawaii Traffic Projections Source: Hawaii Tourism Authority