Alaska Air (NYSE: ALK) is a major player in the West Coast-Hawaii air travel market today. In fact, the carrier says it operates more flights between the West Coast and Hawaii than any other airline -- an average of 29 daily round trips.
However, competition is increasing rapidly. Last year, industry capacity between the western U.S. and Hawaii surged 10.7% -- largely driven by United Continental and Hawaiian Holdings (NASDAQ: HA) -- putting pressure on fares. Industry capacity growth is set to accelerate again over the course of 2019, as Southwest Airlines (NYSE: LUV) moves into Hawaii for the first time. This action could potentially provoke more fare wars.
Let's look at whether Alaska Airlines has the tools to remain successful in Hawaii as the competitive environment changes.
Hawaii is an important market for Alaska Airlines
Alaska Airlines entered the Hawaii market relatively recently, launching a Seattle-Honolulu route in late 2007. Within two years, it was operating an average of more than seven daily round trips to Hawaii from its main operating bases in the Pacific Northwest -- Seattle, Portland, and Anchorage.
Alaska Airlines began flying to Hawaii less than 12 years ago. Image source: Alaska Airlines.
However, about half of Alaska Airlines' flights to Hawaii originate in California today. That's because Aloha Airlines and ATA Airlines -- historically big players in the California-Hawaii market -- both folded in 2008. Alaska stepped in to fill that vacuum, adding numerous routes to Hawaii from cities such as Oakland, Sacramento, San Diego, and San Jose.
For most of the past decade, it faced limited competition in these markets. The legacy carriers were retrenching from routes outside their hubs, Southwest Airlines didn't fly to Hawaii, and Hawaiian Airlines couldn't serve midsize markets profitably, because of its reliance on widebody jets with more than 250 seats for its West Coast flights.
As a result, Hawaii flights now account for close to 15% of Alaska Airlines' capacity. But the conditions that enabled Alaska's big expansion in Hawaii are disappearing.
Strategy changes at two key rivals
The first change to the competitive environment came with Hawaiian Airlines' decision to order the 189-seat Airbus A321neo to complement its widebody fleet. Since the beginning of 2018, Hawaiian has used its A321neos to enter several markets where Alaska Airlines previously offered the only nonstop flights, including San Diego-Kahului, Oakland-Lihue, and Sacramento-Kahului.
Hawaiian Airlines has added new West Coast-Hawaii routes recently. Image source: Hawaiian Airlines.
More recently, Southwest Airlines has added Hawaii to its route network. By the end of this month, it will operate six daily round trips to Hawaii, connecting Oakland and San Jose to Honolulu and Kahului. Once its Boeing 737 MAX 8 fleet gets back in the air, it plans to add numerous additional routes, including Hawaii flights from Sacramento and San Diego, as well as nonstop service to two more Hawaiian destinations -- Kona and Lihue.
As a result, capacity to Hawaii is currently growing more than 20% annually from Oakland, Sacramento, and San Diego. By next month, capacity between San Jose and Hawaii will likely be up by a similar amount on a year-over-year basis.
Today, about a third of Alaska Airlines' flights to Hawaii originate in these four cities where Southwest Airlines and Hawaiian Airlines are both looking to grow. For now, fares seem to be holding up, but with industry capacity growth still ramping up, that could change -- especially during the offseason later this year.
Alaska Airlines wants to stay -- but can it afford to?
So far, Alaska Airlines' management has expressed a commitment to maintaining the airline's position in Hawaii. That said, Alaska can't pursue growth at the expense of profitability. Last fall, the company set a 13% to 15% target range for its pre-tax margin. Achieving that target won't be easy, so Alaska Airlines can't afford to keep routes that underperform.
From Oakland, Alaska Airlines only flies to its Seattle and Portland hubs, aside from its Hawaii flights. It offers just slightly more service in Sacramento. In San Jose and San Diego, Alaska is the No. 2 carrier, but in both cities, Southwest Airlines has nearly three times its market share.
Thus, Southwest Airlines has a much bigger built-in customer base in the California cities where it plans to compete with Alaska Airlines' Hawaii flights. It can also capture more connecting traffic in those cities. As for Hawaiian Airlines, its specialization in the Hawaii market and the connecting service it offers within and beyond Hawaii are key competitive advantages.
Importantly, Southwest Airlines and Hawaiian Airlines probably also have lower unit costs than Alaska Airlines for routes to Hawaii.
Half of Alaska Airlines' Hawaii flights originate in Seattle, Portland, or Anchorage, and those routes aren't going anywhere. But for California-Hawaii flights, Alaska may struggle in the long run to meet its margin target for routes that face nonstop competition, outside its larger focus cities of San Francisco and Los Angeles. Fortunately, Alaska Airlines should have no trouble redeploying the planes used for those routes today to more profitable opportunities elsewhere.
10 stocks we like better than Alaska Air Group
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Alaska Air Group wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of March 1, 2019
Adam Levine-Weinberg owns shares of Alaska Air Group, Hawaiian Holdings, and Southwest Airlines. The Motley Fool owns shares of and recommends Southwest Airlines. The Motley Fool recommends Alaska Air Group and Hawaiian Holdings. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.