We believe shares of Hawaiian Holdings Inc. ("HA" or "Hawaiian") are grossly undervalued, reflecting a deep misunderstanding of the company's economics. In 2010, HA began investing heavily in growth, implementing a capex program to build additional capacity primarily in support of new international routes. Being that initiating services on routes involves start-up costs, and that from the time service is initiated they take 3 years to reach optimal profitability (i.e., to mature), HA's GAAP margins were negatively impacted; put another way, from 2010 - 2013, when HA was expanding most aggressively, its GAAP financials both understated and obscured its economic potential.
With the capex program approaching completion, HA is at an inflection point: As capex decelerates and new routes mature, we expect Hawaiian's GAAP financials to begin reflecting its economic potential. We expect margins to rise in 2014 and free cash flow to turn positive in 2015, opening the door for capital returns to shareholders. In 2016 alone, we project the company will generate free cash flow equating to 35% of its current fully diluted market capitalization.
Meanwhile, Wall Street analysts and investors appear to be missing the forest for the trees in assuming continued deterioration or the status quo into the future - that HA's current financials represent its future - and use this as justification for valuing it at a depressed multiple.
We believe Hawaiian stock has an intrinsic value today of $20 per share, >97% above current trading levels. The significant disconnect presented by HA's valuation is sweetened by several near and intermediate-term catalysts we believe will drive share price toward intrinsic value:
Margins Set to Rise as Growth Slows in 2014, GAAP Financials to Begin Reflecting HA's Potential:
With exception to initiating service to Beijing, HA is pausing new route initiations in 2014. By Q4, only 8% - 10% of HA's routes will be less than 1 year old. We expect this to translate into improved unit revenues and margin expansion; our assumptions are supported by management expectations.
Significant Free Cash Flow Generation on the Horizon:
HA will begin generating FCF when its capex program ends in 2016, opening the door for capital returns to shareholders. In 2016 alone, we estimate HA will generate FCF of ~$200m, equating to ~35% of its current market cap. By simply taking its 2016E net debt/EBITDAR up to the peer average, it would in theory be able to implement share repurchases totaling $500m, equating to ~90% of HA's current market cap! Even if the company desired to maintain a more conservative balance sheet such that net debt to EBITDA was contained to 1x, it could still initiate a repurchase or dividend program to return ~$200mm over the next 2 years and does not jeopardize its capex plan. While shareholder capital returns of such size may be overly ambitious, we believe that even a modest program of $50mm in 2014 is easily affordable and would be well-received by the market.
Management Appears Open to Returning Capital to Shareholders, for the First Time in Years:
Indications from the most recent earnings call suggest that in light of HA exiting a period of heavy investment, management is at least giving thought to the potential of shareholder capital returns - for the first time in years.
Prominent Activist/Stock Picker to Join HA's Board this Month:
When HA's February 2014 board meeting takes place, Zac Hirzel, an investor activist with an outstanding track record as a stock picker, will assume his role on HA's board. Being that he has become HA's largest shareholder, with a 10.8% stake, he is likely to be influential; no other board member has a shareholding of any significance, with the exception of HA's CEO, who has a 2.3% stake. Hirzel's involvement reestablishes the linkage between boardroom decision-making and shareholder interests, a bond founded on shared incentives. David Einhorn's fund of funds manager, Greenlight Masters, is an investor in Hirzel's funds, and according to their recent shareholder letter, "Hirzel envisions a number of ways to create shareholder value (at Hawaiian)."
Dramatically Undervalued, Heavily Shorted, and Just Plain Unloved:
HA is the most underappreciated among equity in the airline sector: HA is cheaper than every single domestic carrier on every relevant trailing and forward metric, and is one of the cheapest airline equities in the world. HA is among the most highly shorted equities of all airlines. Its share price performance has lagged that of the majority of its peers. Lastly, even the sell-side cannot manage to like HA equity; 5 of 8 analysts rate HA equity at either Neutral (3) or Sell (2).