The Hawaii market has been a big part of Alaska Airlines’ (NYSE:ALK) growth story over the past five years. The carrier benefited enormously as it moved quickly to fill the gap left in this market by the closure of Aloha and ATA Airlines in early 2008. Today, Alaska operates 26 daily non-stop flights to Hawaii from its hubs on the west coast compared to zero flights from the carrier to Hawaii in 2007. ((Alaska’s presentation at JPMC conference, March 4 2013, www.alaskaworld.com))
But the growth opportunity in the Hawaii market is dropping fast. This is indicated from the fact that the addition of flying capacity by Alaska and other airlines on these routes over the past 4-5 years has more than made up for the gap left by Aloha and ATA. In mid-2008, after Aloha and ATA closed down, total daily airplane seats from the west coast to Hawaii dropped to 11,400, from 13,700 in 2007. Today, daily airplane seats from the west coast to Hawaii have recovered to 14,100. 
So, where can Alaska add flying capacity now? Or in other words, where can Alaska find its next opportunity for growth? In the near term, we believe the carrier has growth opportunities on routes connecting its west coast hubs to east coast and mid-continental markets. In the long term, the growing demand for air travel from Mexico and Latin American countries could present strong growth opportunities.
We currently have a stock price estimate of $54 for the airline, marginally below its current market price.
The share of Hawaii market in Alaska’s growth over the past 4-5 years
From 2008 through 2012, Alaska significantly raised its flying capacity on Hawaii routes. In 2008, the carrier flew 1.1 billion seat miles on these routes. In 2012, this more than quintupled to 6.2 billion seat miles. This increase of 5.1 billion seat miles was larger than the overall capacity expansion of Alaska during this period. Overall, Alaska’s flying capacity increased 3.5 billion seat miles during 2008-12 (from 27.9 billion seat miles in 2008 to 31.4 billion seat miles in 2012).  This effectively means that the opportunity in Hawaii compelled Alaska to divert its flying capacity from other (comparatively less profitable) routes to destinations in Hawaii.
However, Alaska’s year-over-year capacity addition on these routes has been declining. Over 2011-2012, the carrier increased its annual capacity by 38% on these routes. In comparison, for 2013, Alaska forecasts to raise its annual capacity by only 5% on these routes. 
Growth opportunities lie in mid-continental and trans-continental markets
Over the next 3-4 years, the carrier could add capacity in mid-continental and trans-continental markets from its hubs on the west coast. Currently, Alaska sees frequency opportunities out of Seattle, Portland, California and even the state of Alaska. In California, which today constitutes around 20% of Alaska’s capacity, customers are increasingly adopting the carrier to fly to Seattle, Alaska and Hawaii.  Thus, the carrier has an opportunity to strengthen its customer loyalty in this region and use that to raise its passenger traffic to mid-continental and east coast markets.
This rise in capacity will have to be supported by a stable demand environment, which is likely, as the U.S. economy and demand for flights are likely to continue to grow, albeit slowly, in the near term.
However, margins for the carrier on these new routes will likely be lower than its current system average as competition on these routes is higher. Nonetheless, as long as Alaska can get margins that allow it to maintain its 10% return on invested capital (ROIC) (post tax) target, it will continue to expand to these new routes. Last year, the carrier generated an ROIC of 13%. 
Beyond 3-4 years, Alaska could look to expand its services in the Mexico market. Currently, Mexico constitutes 7% of the carrier’s total capacity. Alaska could also look to expand into the fast-growing Latin American markets where some other carriers like Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU) are witnessing strong growth.
In 2013, Alaska will increase its fleet size by 3 to reach 175 aircraft. It will then maintain its fleet size over the next two years, as projected by the carrier. From 2015 through 2022, it will start taking deliveries of 50 Boeing 737NG/MAX aircraft. This fleet expansion 2015 onward will allow Alaska to raise its flying capacity to destinations in Mexico and Latin America. Notes: