Frontier Group Holdings, Inc. (ULCC) Earnings Call Transcript & Summary

Good afternoon. Welcome to Barclays 43rd Annual Industrial Select Conference. I'm Brandon Oglenski, airline and transport analyst. And next up on the airline track, we have Frontier joined by Jimmy Dempsey, CEO; and Mark Mitchell, CFO. We have plenty to get into here just given what's been a pretty volatile ride for a lot of airline equities in the last 12 months, I'd say. But Jimmy, Mark, thank you for coming down.

Thanks for having us Brandon.

Yes. I mean plenty to talk about specific to your company. But I think in general, what we're seeing across the market is just a better environment for airline demand right now. While we got a mic issue fixed here. But Jimmy, I know, maybe you can just talk to the general health of the airline market today versus where we were, let's say, 12 months ago.

Yes. Look, we're seeing 2 things in our business. One, we're seeing constructive supply-demand dynamics. We've certainly seen a very constructive capacity over the last number of months, and we're managing through that in a very productive way. The second thing we're seeing is real discipline coming into our pricing strategy and the way we're merchandising our product. In mid-October, we moved to -- back to a very distinct basic fare plus bundle strategy. And that allied to the introduction of NDC onto our online travel agents is enabling customers to make a very simple value decision in our business. And so we're seeing about -- in Q1, about a 10-plus percent improvement in stage length adjusted RASM year-over-year, which is really positive into our business. When we saw the shutdown back in November, that cost the airline close to $30 million in both perishable seats that we didn't sell in November, plus also forward bookings into December peak. We recovered that throughout December given the improving demand environment and also some of the things that we've been doing in terms of the pricing strategy we have. We've seen that carry forward into January and February now, and the trends are looking very, very positive into March. So we feel pretty good about the unit revenue environment that we're in right now.

Okay. And I think the guidance for 1Q is roughly flat or slightly down capacity and again, 10% unit revenue growth. Is that just driven by your own initiatives? Or is the industry pricing as well has gotten stronger?

Well, there's the macro event that happened last year that caused unit revenues to fall off as the quarter progressed a year ago. Actually, what we're seeing at the moment is slightly shrinking capacity in January and February, but growth in capacity of about 8% in March. And actually, March, we're seeing the biggest year-over-year improvement in unit revenues and total revenue. And given that March is the biggest revenue month of the quarter, we're actually seeing pretty good performance in March as we trend into selling the rest of the spring break season.

Okay. Appreciate that. I guess more strategically, though, looking beyond the near term here, it's been a pretty rough few years for low-cost carriers in general, and your results have been a little challenged too. And obviously, there's been a leadership change at the company here recently with you taking over as CEO. And we all know in the past that there's been attempts to merge with your large competitor who's now in their second bankruptcy and getting smaller. I guess adding all this up, Jimmy, what's your biggest priority taking over Frontier?

Last week, I announced a list of tasks that we have in the airline. We were very focused on rightsizing the fleet. And the airline got out of sync from an aircraft perspective to the activity in the airline. And so we addressed that with taking 24 aircraft out in a deal with AerCap that will close in the next few weeks. Those aircraft leave our fleet in April, May and early June this year. And so that rightsizing is a meaningful change in the ownership cost of the business. We then also adjusted our longer-term growth profile to somewhere around 10%, 8% to 10% going forward and adjust it to about an 11.5 hour utilization, what we call utilization rate, so the productivity of the airline. Last year and the year before, our utilization of our assets dropped quite meaningfully to the point in Q4 where we had a utilization rate of less than 9 hours. We'll move that back towards 11.5 hours over the next 18 to 24 months. And that will put the airline in a very productive state, which will take unit cost down overall for the airline. Big change -- the second big change that we focused on is driving a strengthening cost discipline into the airline. And so partly benefit from the rent reduction that we have of close to $100 million. And the other $100 million that we anticipate to take out will come from efficiencies associated with moving that productivity back into the airline and network selection across the business. So those 2 key things are something that we worked on very hard in the last 2 months since I took over. And then we're really working on solidifying the operations performance of the airline, so reducing cancellations and improving our on-time performance. I think that's a very, very important next step in the airline to do that in order to improve the loyalty and repeat business of the airline, which ultimately, we want to create a very stable revenue base. And so having slower growth as opposed to 20% plus growth, having growth in the 8% to 10% zone over the medium term plus a better operational performance, we think will give real stability and improvement to our revenue base that has been missing for the airline for the last couple of years.

Okay. I think also on earnings, you also announced a new order book with Airbus. Is that right or a change order book?

Yes, we deferred 69 aircraft with Airbus, which slows the growth rate of the airline. So it moves the aircraft from 27, 28 and 29 into 2031, 2032 and '33.

And again, that aligns you better with the 8% to 10% growth rate is that -- that's right.

That's right.

Okay. Can you talk about the AerCap deal specifically, there going to be any upfront costs with this that shareholders should be thinking about?

Do you want to talk?

Yes. I mean, so we will have, as we complete the transaction, some costs that are on our balance sheet that are noncash at this stage will get expensed. But for this year and next year, there is no significant cash penalty to the business.

Okay. And I guess, can you put this in the context of the lease extensions you guys actually executed, I think, maybe the last 2 years, obviously, under different circumstances, but...

So in context -- so help me understand the question.

Well, just -- so you were extending leases not that long ago. and now we're sending aircraft back. So just...

Yes, yes. Yes. So relative to the extension, so as we set our leases up, our leases are set up based upon a certain utilization assumption and trying to time our maintenance bill with that utilization. As the airline over the last couple of years brought its utilization down, there was a disconnect in timing between expected maintenance and what the return cost of the aircraft would be. So to optimize that maintenance, we look to extend the aircraft, take advantage of that maintenance optimization, the lower rent and in certain cases, engines and aircraft that had better reliability than some of the newer engines that were coming online.

Right. Because the deal with AerCap is returning A320, is that right?

Yes. So then the deal with AerCap is taking advantage of a situation where there is a need for spare engines and that need for spare engines drove some economics that we were able to take advantage of to, as Jimmy mentioned, rightsize the fleet, get our fleet down to a level where we can get utilization to where we believe it should be and do that in a way that doesn't create a cash penalty for the organization and actually create efficiencies as we move forward.

Okay. And on the new order book with Airbus or the deferrals, how does that change your PDP requirements?

Yes. So what we highlighted as part of our guide, we expect our PDP balance to drop by somewhere between $170 million to $210 million this year when you look end of '25 to end of '26. So given that we are pushing aircraft out, those PDP requirements go down. As the PDP asset balance goes down, you also have a corresponding decrease to the debt balance.

Okay. Jimmy, I guess, outside of the changes to the fleet, which I think could be helpful to get utilization back to where you want it. I think what investors are a little concerned about is you're seeing good unit revenue performance now. And I think that March comment, maybe we can unpack that a bit more. But as we look out into the second quarter or third quarter, obviously, ASMs are going to be up double digits, I think, according to plan. Can you maintain a double-digit unit revenue profile even with capacity growth?

I mean I'm not sure our state adjusted RASM needs to be up double digit in terms of RASM going into the rest of the year in order to hit our guide for the year. But one of the things that we're seeing in the business, which is very interesting, take March as an example, our capacity is up 8%. We expect our unit revenues to be up higher than 10% in March alone year-over-year, and that should carry forward into April, May and June based on what we see in terms of the supply-demand dynamic and also some of the things that we're doing in our business this year. I mentioned earlier that we have moved quite quickly to having NDC and transparency in terms of giving the customer the ability to see the value that they have when we line up against other airlines and online travel agents. We obviously moved to that process 2 years ago on our own website. but had a delayed start in NDC. That's actually showing real benefit into the business today. And so if you look at the 10% plus RASM move this year, half of that is linked to the supply-demand dynamic that exists and half of it is through actions that we have made ourselves. So that gives us confidence that our unit revenues will be up in spite of capacity growth in the coming quarters to actually match our internal targets that we have this year. So we're pretty -- we feel pretty good about the revenue environment that we're experiencing at the moment.

And Jim, just for those that don't know, NDC, maybe unpack that a little bit for the layman.

Yes, it's effectively a direct connect between us and the online travel agents as opposed to going through a global distribution system.

But the importance of that is that you can now market your products better, right?

So if you look at the Frontier website, you'll have a basic fare plus 3 bundles. If you go to an online travel agent, you previously had the basic fare and then you came back to Frontier through manage my booking or a check-in and bought an a la carte bag seat or a bundle. Today, now you're able to buy that directly on the online travel agent at the point of booking. And so what we're experiencing is an improvement in conversion and attachment across the business, both on our website and also on OTAs, which is really favorable to the business. And you're seeing our volume business come back. And so -- which is very important to a carrier like Frontier. The last couple of years, we've had load factors under some pressure. And so what we're seeing right now is load factors are coming back and recovering and so improving year-over-year, but not at the expense of fare. And so that's a very positive sign for the business.

Okay. I mean I think the larger airlines will say we still see challenges in the main cabin, effectively saying premium products are outperforming. How would you address that?

Look, we have studied what the big guys are doing across the U.S. We see a real opportunity for Frontier in expanding its loyalty program. Our cash flows from loyalty assets, particularly the credit card program are quite immature in comparison to the major airlines across the United States that we compete with. We don't anticipate moving our cash flows towards their levels, obviously. They have a significant scale advantage and international aspirational travel advantage against us. But we certainly see real progression in terms of cash flows over the last 2 years as we've invested heavily in the loyalty program, and we'll continue to do that over the next 2 years. Our cash flows in Q4 were up 30% year-over-year, which is a meaningful improvement in cash flows. And that's pretty much on volume -- static volume across the fourth quarter. So we have invested quite heavily in the loyalty program. We're seeing real results come through in that. And so the next 2 things that we're doing in the business to step into that premium product offering that we're learning from the major airlines is adding a first class seat that comes later this year. And then we're getting close to selecting a WiFi provider that we think will be installed and operational between now -- by the end of 2027.

Okay. Interesting. From a network perspective, I think a lot of folks have noticed that you were a little bit late to file your 2Q schedules. Can you talk to the rationale behind that? And then what are the priorities for growing the network this year?

Yes. We delayed launching the network because we were in the process of figuring out a rightsizing on the fleet. And so the schedule from mid-May on was delayed somewhat. It's on sale now to the end of August. We will refine that over the coming weeks and probably take some of the capacity down 1 or 2 points in Q2, for example. We have a schedule out on sale, and we're just refining the timing of when the 24 aircraft exit the fleet. And so you'll see some refinements, down in terms of capacity adjustments in Q2. And so that should be positive to the business.

I think markets like Atlanta have been new for you guys, right, or bigger push.

We've seen -- like we've seen 2 things happen, for example, in Atlanta. Southwest has reduced capacity in Atlanta and Spirit has reduced capacity quite considerably in Atlanta. So we're largely replacing the capacity that they have exited from over the last few years. And we're seeing really good performance and strong performance in Atlanta. In addition to that, we're seeing really good performance across the West of the United States. Spirit has obviously shrunk its capacity considerably in the West of the U.S. And so we're seeing real opportunities in Las Vegas and elsewhere where fares were heavily discounted previously and now are no longer being discounted heavily by Spirit because it's not in the market anymore. I mean if you look at Frontier over the last 3 or 4 years, you've seen the overlap between Frontier and Spirit at somewhere between 40% and 50%. You're seeing that overlap reduce quite considerably, and we think that's actually quite structurally favorable to the business going forward.

Okay. I'll ask this question gingerly, but there's been a lot of discussion of M&A across the industry with some deals live right now, too. I mean, how important is that to maybe fixing some of the problems at the low-cost level? Or is there a path forward for Frontier here on your own?

Yes. I mean we have spent the last couple of months putting a plan in place to build -- bring the airline back to sustained profitability. We think we have a really good plan that we've put in place. We've got to invest in bringing back the productivity in the airline this year. If you look at what we've done, you effectively have the same number of aircraft at the end of last year to the end of 2027. And so all you're doing is infilling the productivity into the airline that has been reduced over the last few years. And so that kind of growth is effectively infilling a network that already exists. And we think that, that's very favorable for the business. So we're very, very focused on building a sustainable, profitable path for Frontier as opposed to consolidation in the industry.

Okay. if I could just push back though because some CEOs would say, oh my gosh, we're at a competitive disadvantage, especially on loyalty. You mentioned it as well that you just won't be at the same relative levels as maybe some of your larger competitors. But do you view that as potentially an opportunity as well?

I think it's a great opportunity for us. I mean our average cash per passenger is about $7 if you incorporate our credit card, our GoWild! program on Discount 10. And so that's considerably below the rest of the industry. And so there's huge leverage in our loyalty program, given the investments we put in, the investments we plan to do into it, we think that there's real opportunity to enhance the cash flows coming off the loyalty program in the coming years.

Okay. And if there's any questions from the audience, just raise your hand, we'll get you a mic. I guess, Jimmy, how much cost is tied up in the underutilization today that you think you can address going forward?

Well, primarily, the rent, you can see in the ownership costs. We are reducing our rent bill by close to $100 million. So that's a meaningful cost reduction that comes with those aircraft exit the fleet. And there's probably another $60 million to $70 million of inefficiency in the business, direct cost inefficiency in the business that will come out with the utilization change. And that's managing the -- just take, for example, managing your real estate assets across the week. You have -- you're underutilizing the real estate on a Tuesday and Wednesday, and now you'll use them a little bit more across the week, and so you get a real fixed overhead benefit in the business. And so if you look at Frontier and the movement back to higher utilization, our marginal cost of producing that season on a Tuesday and Wednesday is significantly lower than the rest of the industry. And so what we're moving back to is ensuring that the contribution comes towards the airline and the ownership cost of the airline by operating on those days. And I think that contribution is very, very important to the overall profitability of the airline. And it will effectively make the peak days of the week more profitable than they are today.

John?

With the addition to more capacity on the off-peak days, will that be absorbed by the market or have any effect on unit revenues? And then could you also just comment on the cost aspect, how are things developing with the pilots and that negotiation that's ongoing?

Yes. I'll deal with the pilot negotiation is ongoing. We're in mediation with the [indiscernible]. And so that process will continue. Obviously, the pilot body is a very important part of the airline. And so we'll go through that process this year and see how we get on. In terms of the cost revenue dynamic, we are infilling our existing network in a large part in terms of the utilization that's coming into the business. And so that's less expensive from a revenue perspective. than adding new markets into the business. So about half the growth that we expect this year is coming from an improved -- or sorry, increased use of our existing network. The other half is from opportunities, as I mentioned to Brandon earlier, around markets where we see a reduction in capacity in the industry.

And Jimmy, I think you hit on something that you're seeing volume come back. So is it like the off-peak volume that just wasn't there for a while?

It's both. Yes, we're seeing real improvement in the booking curve and earlier in the booking curve. And so we're experiencing an ability to yield up and yield up not at the expense of volume. And so you're seeing your load factor improve in the airline at the moment.

Well, I guess, how would you characterize your customer profile as well because we hear so much about the supposed K-shape economy and the haves and the have-nots. But is that the case for your business as well?

I mean this is difficult to separate out. Like we have a mixture of customers across all the demographics in the economy. What we're actually experiencing at the moment is a higher conversion and attachment rate from customers across both our website and on online travel agencies across the spectrum. And so I think it's more to do with the fact that we're displaying the value we provide and clarity in terms of what people are purchasing compared to where we were previously. And I think that's actually giving us a lift.

I think you maybe mentioned it, is domestic first class still on track?

It's -- we expect to have that installed by the end of this year.

Across the fleet.

Across the entire fleet.

And when do you plan to go live with that as a product?

Well, we sell at the moment Upfront Plus, which is effectively like European business class. So we block the middle seat on the first 2 rows of the aircraft. So we're selling that today. We're not selling it necessarily as a first-class product. But we will navigate from Upfront Plus into first class when we get clarity on exactly the launch date in the fleet. So that will happen as you progress through this year.

Okay. Obviously, it's good to get utilization back up. But as you defer aircraft, something else has been happening with the sale leaseback gains because you get pretty sizable gain when you take a delivery of new Airbus and do that transaction. So how are you going to offset that as you lose that contract expense, Mark?

Yes. I mean I think the combination of the lower rent bill we talked about, the efficiency that you're getting across the business on top of the fact that the maintenance bill tied to those 24 aircraft, given that they were kind of mid-life was significant. When you take the combination of those items, they more than overcome the sale leaseback that assuming you continue to sale leaseback in the future is pushed to the right.

Okay. So you're accruing maintenance expense on those 24 leases then?

So we weren't accruing lease return costs because they weren't, for the most part, in that lease return window. As you get close to the end, that's when we accrue. But they were at a point in their life cycle where you were incurring and expected to incur in the near term, meaningful maintenance costs that now with the early return of those aircraft, those maintenance costs you're able to avoid those. So again, the combination of the rent, the avoidance of maintenance costs and the efficiencies you're getting across the business, those items overcome and help you to move off of that sale-leaseback dynamic.

Okay. And I think you guys mentioned earlier about focusing on operations getting more reliable. What are the drivers there?

I mean, look, it's -- we want to run a much better airline. It starts as operating performance to your customer. We want to improve particularly the on-time performance of the airline. And if we improve the on-time performance, we'll naturally improve the cancellation rate that exists in the airline, excluding air traffic control and weather issues that exist. So we're very focused on fixing some of the issues that have existed in the airline around ensuring that we have an on-time performance. I'll give you like a simple example. We're changing the focus around the turn and creating some automation in the turn that will save us some time in the turn. And we're going to maintain the turn times in place, but use that time to ensure that our turns actually go on time as opposed to bleeding 1 or 2 minutes every turn in the aircraft. That's actually a meaningful improvement if you roll that across all the departures you have in the day. The second thing we're doing is matching and optimizing our maintenance footprint back into our network plan. So our network plan is set now for the next 3 or 4 months. We'll tweak that over the coming months, but optimizing the task list for each of the aircraft so that the routing of the aircraft touches the right base at the right time. And so that will actually improve the first wave departures in the airline every day. And so we're very -- and we have a litany, we have about 60 projects that we're working through. We think those 2 projects are meaningful adjustments in the airline. It will take time to get that deployed across the fleet. But I think it will actually give us much more certainty in terms of the performance of the airline from an operational perspective, and it feeds into our push for improving the loyalty and retention of the customer that we want to bring into the airline so that we have much more repeat customers in the air.

Okay. And this is different from like opening new crew bases that you guys were trying to address this within the past, right?

Yes, we have 13 crew bases across the U.S. at the moment. So it's not opening new crew bases necessarily to solve this issue. It will be advancing the maintenance footprint in some of those bases so that we have capabilities that exist across the U.S. that touches the aircraft on a more frequent basis.

Yes. And I guess, Jimmy, as we only have a couple of minutes left here, didn't mean to be too negative here. It's been a difficult run and we've covered you since the IPO. And obviously, shareholders have seen the stock perform the way it has. But I guess looking forward, what do you ultimately see Frontier generating? Is it -- can this be a double-digit margin business? If so, I mean that...

I'll tell you where my focus is at the moment. It's clearly bringing the airline back to a sustainable profitable place. I'm very focused on bringing operating cash flows back into the business. I think the airline has relied too heavily on sale and leaseback gains over the last couple of years, and we need to focus on bringing those operating cash flows back in. And part of that is balancing the network and the deployment of our assets. And so bringing productivity back into the airline, I think, is part of that strategy. What we're seeing in terms of our revenue performance and the revenue performance across the industry is very favorable at the moment. And so I think that leads us to a very strong path back to profitability for the airline and fundamentally generating operating cash flows in the business. That's where my focus is. We have a lot of stakeholders in the business, both investors, employees and customers. And we provide real value to customers today in terms of the lowest fares in the industry. And I want to bring the airline back to making sustainable profitability in order for us to grow the airline over the medium term and long term, excuse me.

Okay. Well, Jimmy, Mark, thank you very much for coming. Appreciate you being here.

Thank you. Yes. Thanks.

Appreciate it.