Monday, May 22, 2017

Southwest Airlines Gets Serious About Hawaii

Flights to Hawaii are starting to move towards the top of Southwest Airlines' list of future growth opportunities.

For years, Southwest Airlines has been talking about Hawaii as a future market for growth. However, it has never been the carrier's top priority. In recent years, there have always been more compelling or time-sensitive opportunities to soak up Southwest's capacity growth.

That's starting to change. At Southwest Airlines' annual meeting last week, CEO Gary Kelly indicated that entering the Hawaii market is now a "high priority" for the company.

Southwest's attention has been elsewhere

Ever since it added Boeing's 737-800 to its fleet five years ago, Southwest Airlines has highlighted Hawaii as a potential new destination. Yet the carrier has instead pursued a series of one-off opportunities to grow in capacity-constrained markets since then.

In 2014, as part of the American Airlines-US Airways merger, Southwest acquired slots at LaGuardia Airport in New York and Reagan Airport near Washington, D.C. Putting those slots to use was a key growth priority for 2014.

In late 2014, Southwest Airlines' home airport -- Dallas Love Field -- opened up to longer-haul domestic flights, after years of being limited to short-haul routes. This represented an even bigger opportunity, driving the bulk of Southwest's 2015 capacity expansion.

For the past two years, international markets have been the key growth driver. Southwest opened an international terminal in Houston in late 2015 and it is scheduled to open a new one in Fort Lauderdale, Florida this summer. These cities are becoming Southwest's two main international gateways, although the carrier operates international flights from some other cities, too.

Hawaii comes into focus

In contrast to the recent past, Southwest doesn't have any well-defined growth plans for 2018 and beyond. As a result, Hawaii seems to be rapidly moving up management's priority list.

Southwest Airlines will start adding the 737 MAX 8 to its fleet later this year. The MAX 8 will have more range and be more fuel efficient than any of the aircraft in Southwest's current fleet, making it an ideal plane for flying to Hawaii.

That said, Southwest is in the midst of retiring the last of its older "Classic"-series aircraft. As a result, its fleet size is scheduled to increase just 3% from the beginning of 2017 to the end of 2018. Additionally, there is a lengthy certification process for operating long over-water flights, like the ones from the West Coast to Hawaii. Southwest hasn't even begun that process yet. Both of these factors suggest that Hawaii flights won't launch until 2019 -- or even 2020.

Should Hawaiian Airlines be worried?

Not surprisingly, shares of Hawaii-focused airline company Hawaiian Holdings fell last Wednesday, following Kelly's comments about Southwest Airlines expanding to Hawaii. However, while Southwest's entry into the Hawaii market could cause some short-term disruption, it isn't likely to hurt Hawaiian Airlines' positioning in the long run.

Southwest hasn't said yet which bases it might use to fly to Hawaii. However, it's reasonable to expect that it would be interested in Hawaii flights from many of Hawaiian Airlines' 10 destinations in the western U.S.: Los Angeles, San Diego, San Francisco, Oakland, California, San Jose, California, Sacramento, California, Portland, Oregon, Seattle, Las Vegas, and Phoenix. (The latter two would probably be feasible only with the smaller and longer-range 737 MAX 7, though.)

In the biggest cities (Los Angeles, San Francisco, and Seattle), Hawaiian already faces lots of competition. It has still managed to generate a consistent revenue premium thanks to its good service and unique focus on providing Hawaiian-style hospitality onboard.

Competition is lower on Hawaiian Airlines' routes from cities like Oakland, San Diego, San Jose, and Sacramento -- all of which are prime candidates for Southwest service to Hawaii. That said, by the time Southwest would be ready to launch service to Hawaii, Hawaiian will probably have switched to its new A321neo fleet on these routes.

Indeed, the A321neo will be critical to Hawaiian's ability to fend off new competition from Southwest Airlines. It will be roughly comparable to Southwest's 737 MAX 8 fleet in terms of unit costs. The A321neos will also include 16 first class seats and 45 extra-legroom economy seats, boosting their revenue potential.

Southwest Airlines is likely to see strong demand for its flights to Hawaii, whenever they take off. It is the No. 1 carrier in many West Coast cities, which means that it is starting with a large base of frequent fliers and can also offer lots of connecting options. Nevertheless, Hawaiian Airlines' unique in-flight experience, its premium seating options, and the low costs of its new A321neo fleet will help it remain strongly profitable on West Coast-Hawaii routes.

(Adam Levine-Weinberg - The Motley Fool)

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