Sun Country, Inc. (SNCY) Earnings Call Transcript & Summary

Okay. Good morning, everyone. I'm Brandon Oglenski, airline and transport analyst. And welcome to day 2 of our 39th Annual Industrial Select Conference. Very happy to have Sun Country Airlines for the first time here. Joining us is Dave Davis, CFO of the company.

So very interesting story, Dave, because you guys just IPO-ed last year, differentiated airlines. So I want to talk about the differentiated story here for folks that maybe don't know you and why you guys are already profitable even during the pandemic.

Yes. So we are an LCC headquartered in Minneapolis. We went public in March of '21. We're an Apollo portfolio company, and they're still a big owner of the business. But we have -- we operate a unique model. It's -- there's not another peer in the industry. Essentially, we fly all 737 fleet, 737-800s for the most part, across 3 different business segments. So we have a scheduled service segment, which is selling tickets to passengers. We have a charter segment, which is doing charter flying for the likes of Caesars Entertainment, MLS, the military, and we have a cargo business. The cargo business, we operate 12 737 freighters for Amazon. Our total fleet is about 50 aircraft now, and we're growing very rapidly. We'll add 8 aircraft to that this year. I think what makes our model very unique is our ability to utilize our assets across all 3 segments. So our pilots are fungible between each of the 3 segments, we schedule them across all 3. Our aircraft are fungible between the charter and the scheduled service segments. Our scheduling strategy for the passenger business, we have a very peak schedule. So unlike a lot of other carriers that fly very flat schedules through the year or through the month, we have a lot of flying when demand is high and very little flying when demand is low. We fill in the valleys with steady charter flying and steady cargo flying.

Yes. And can you talk to where is demand in your markets? Because I think for the average airline investor, it's been frustrating, we get wave after wave of new COVID variant. It seems like business travel doesn't recover to the levels that we needed to for at least the industry to regain profitability. But with that peak schedule and more leisure focus, where do you guys see demand and yields right now?

Yes. So we're 100%, 99% leisure passengers. We don't cater to business traffic. Given the peakiness of our schedule, it wouldn't really work well for business travelers. Demand for us has been -- I mean we've seen up and down waves with COVID as well, but demand right now is off the charts strong. So really beginning in mid-January or so, we saw a real rebound from sort of an Omicron low, which we have been experiencing for 3 or 4 weeks. And since then, it's been really, really strong, I mean up double digits versus 2019, 2020, 2021. So our markets are leisure passengers traveling on vacation, visiting friends and relatives and the first quarter for us is our strongest.

And what's going to take to regain profitability that you had pre pandemic?

So we were profitable all through COVID. We're the most profitable airline in the country in 2020. We were profitable. A lot of that was due to our cargo business, which was very steady. In '21, we were a leading airline as well in profitability. '22 looks very strong as well. So we've basically been profitable. The answer for us and the challenges facing our airline at this point are really managing growth. So we came into the year with 36 passenger planes, 12 cargo planes. That's the 50-ish I was talking about. We want to add 8 aircraft to that 36. So we're growing very, very rapidly. You'll see us adding 6 or 7 aircraft a year after that. It's a challenge to get really pilots and others. We have a new pilot deal in place, which has helped tremendously. But really, it's managing growth for us right now in an already profitable base.

And can you talk about the rationale for getting the pilot deal done? I think you guys have done pretty quickly, right? What's the cost implications? And what does this allow you operationally?

Yes. So I've done a number of pilot deals -- labor deals throughout my career. This is the fastest by far that we got it done, really from sort of when we began in earnest to completing the deal, it was about 3 months to get a brand-new agreement in place. It's a 4-year deal. The point of doing it quickly was really twofold. One was, given the massive hiring from the legacy carriers, we were -- our attrition was higher than it could be to sustain our growth. So we put this new pilot deal in place. Our wages are now fully competitive with who we consider our competitive peers. Our applications for pilots are up about 160% since the deal was done. So so far, that part of the rationale has absolutely worked. We also needed to get a few changes to the contract in order to unlock additional Amazon growth, which we also got those changes done. Our old contract, our wages were low, set in, I think, probably 2013, 2014-type time frame. So if you look at our pilot cost per block hour, between 2021 and 2022, it's up about 34%. So it's a big increase in that one line item. But overall, our total cost per block hour are only up about 2%. So we've been able to essentially absorb all of the pilot cost increase through savings elsewhere on the P&L at the company.

Can you talk about those savings?

Yes. I mean one is just a culture of strong cost control. I mean our headquarters are in a converted hangar, and we operate a very low-cost operation. We've really sort of been earnestly pursuing reductions in fleet costs now for 3 or 4 years. So our average ownership cost, if I look at 2018 versus today, down about 27%. So that continues to pay dividends for us. Aircraft ownership is one of our largest line items. Our distribution cost is down probably 25% from 2019. Then just across the P&L, we've been able to reduce costs over the last 3 or 4 years and essentially leverage growth by not adding costs as quickly as we're adding ASMs.

And with the pilot deal now, can you fully utilize your fleet and execute your growth strategy?

Yes. So right now, the growth we talked about for the year, we gave some ASM guidance for the full year and then some earnings guidance for the first quarter. We are on track to have enough pilots to be able to support that growth. Ideally, we would grow even faster. That will be a little bit more difficult. But the growth we've talked about and the guidance we've given, we are able to execute.

Okay. And you spoke about some changes that could potentially allow the Amazon contract to grow. Does Amazon want more 737s? And do you view that as a near-term opportunity or longer term?

Yes. Well, I mean, I can't speak for them. So we don't have a lot of insight into exactly what their growth plans are. They have a big wide-body operation, which we don't participate in. And then they have 20 737s flying in the domestic U.S. We have 12 of them. To the extent that they grow that narrow-body fleet, again, I don't have insight into their growth plans, we all know how quickly the company is growing. To the extent that they grow that fleet, I think we would be a very logical participant in that growth.

And can you talk about the contracts? Maybe folks here don't quite understand, but you don't own the aircraft, Amazon does. You're literally providing the pilot services, right?

Yes. So it's -- think of it as kind of a CMI deal like crew, maintenance and insurance. The aircraft are Amazon-owned, Amazon-controlled anyway. We fly the aircraft. They're responsible for the ground handling, loading and unloading of freight. We basically provide the maintenance services. We schedule the pilots, pay for the insurance, get the aircraft from A to B. So it's a very low CapEx model, high margin, low CapEx for us.

Right. And they're paying the fuel bill, too, which is important.

That's the other thing, particularly with sort of fuel costs, the way they've been. Really 1/3 of our total fuel usage, we don't directly pay for that fuel. So between our cargo business and our charter business, fuel costs there are passed through to the end user. So about 1/3 of our total usage is we're not exposed to fuel price changes.

Okay. And by the way, sorry, at the beginning here, I didn't mention, but if you scan the QR code, there's some audience response questions on sentiment towards Sun Country. So helpful if you guys could do that as well. [Operator Instructions] I can read them here. Actually, can you guys refresh us? Thank you. So I want to talk about your commercial strategy, but look, oil is up a lot. And I've asked this of every airline management team. I mean we know historically, there is a lag, but airline revenue generally tracks changes in fuel prices. But I guess what can we do now that's maybe more proactive to try to match fares with the input costs?

Ultimately, the fares in the industry, as we all know, are set by supply and demand. So what needs to happen is if fuel is up for a sustained period of time, capacity comes out of the industry, fares go up and you recoup some of that fuel price movement. That's a time that doesn't happen instantly. So I think what has to happen in the business is probably more moderated growth, which will happen -- which should happen naturally, given that fewer routes will be profitable at $99 oil than they were at $69 oil. The thing that's making it difficult to tell exactly what's happening is the supply -- demand is so strong right now, particularly for, I think, leisure travel that fares are pretty high, the fares that we're selling. So it's hard to say how much of that is a reaction to sustained high fuel prices over the last few months and how much of it is just a return of the of travelers driving fares up.

I guess has it changed any of your near-term planning though for growth?

It really hasn't. I mean we -- like I said before, on the scheduled service side, which is where we're exposed to fuel prices, we have a very peak schedule. So we're really big in the first quarter, a little bit smaller in the summer, but we have -- we redeploy our fleet in the summer. And then in some other months, we fly very little. So we're going after the most profitable traffic. All of our routes, not every single one of them, but almost all of the routes are profitable. We may trim a little bit here and there, but this peak strategy that we have works really well in this environment.

Yes. And for those that don't know, but you're predominantly Minneapolis based, right?

Yes.

And I think when you talk about the trajectory on growth the next couple of years, as you add that, was it 6 or 8 aircraft a year, it's going to be predominantly Minneapolis, is that correct?

I wouldn't say it's predominantly Minneapolis. It will be fairly balanced. So it will probably be a little bit heavier Minneapolis growth in 2022. But after that, we're looking at sort of a fairly balanced strategy. So it will be filling out our schedule in Minneapolis. There's still leisure destinations that we can fly to that we don't today, maybe additional frequencies. And then it's looking for opportunities around the country to do additional flying, of which there's hundreds of markets that we've identified. We have a schedule built out to really 2025 right now. So in terms of how much growth we experienced, we have it down to the route level out that far. So we think there's plenty of opportunity for us.

Okay. And then how does that factor in with your charter business, which again is, what about, 20% of revenue. right?

Yes. Yes. Our charter business is about 20% of our revenue. The two work very closely together. We will literally have flights coming into a city that are a charter flight and then the pilots getting off the aircraft, going on to a scheduled service flight, the airplane continuing onto a scheduled service flight. So they're very closely tied together. What we basically saw through the pandemic was a pullback in charter flying, a lot of it on sort of the military side. And we also saw the influx of widebodies into what had predominantly been narrow-body markets on the charter front previously probably because there wasn't a lot of international opportunities available for large airlines. I think what we see is sort of that beginning to reverse. We've added some long-term contracts to our charter business. And now as the more ad hoc stuff comes back, there's some natural growth built into our charter business as well.

Okay. I think you recently announced a deal with MLS. Is that right?

Yes. So we've signed 2 deals in the last few months that are -- what we call basically track charter. So it's fairly well-known schedule set ahead of time. One of them is with Caesars Entertainment to basically do casino flying, non-Vegas casino flying for them. The other is with Major League Soccer. We fly the teams basically around the U.S. We really like that kind of business because schedules are known to us in advance, which means we can bake that schedule into our pilot bid, more efficiently use our crews than if it's sort of last-minute kind of stuff where we have to use reserve pilots.

Got it. And back to the commercial side, you guys do some flying outside of Minneapolis during the summer months, right? So you're chasing some of those leisure markets. Can you talk to us how that's differentiated and why you guys can do that successfully?

Yes. Again, I mean, it's back to this strategy of pursuing -- flying on routes when demand exceeds supply essentially and then getting out of that market when the dynamic changes. So in our home market, for obvious reasons, demand is very strong in the winter months with people flying to warmer climates. In the summer months, it's sort of less so in our home market, so we move the aircraft around. For instance, we fly LAX-Honolulu between June and August. It's actually one of our most profitable routes and then we're out of that market for the rest of the year. We deploy a fair number of aircraft to Dallas in the summer months. And it's essentially flying people who live in that metro area to the Caribbean, Mexico during the summer months. So there's opportunities for us to move these planes around the country to capture that peak demand. The company is very good at getting into and out of stations quickly and redeploying capacity very quickly.

One, I guess, what's the competitive response? Obviously, Minneapolis is a big hub for Delta. How have you guys coexisted? And as you look to get bigger, do you think you're going to run into more competition maybe from other ULCCs?

I mean you can look at sort of available data. Our share in Minneapolis has been growing steadily now for the last 4 years or so. Delta's share has been growing a little bit as well. And essentially, all the other carriers in the market have gotten substantially smaller. From our perspective, we think we coexist fairly well with Delta. We don't pursue high-margin business traffic. We don't overlap on a lot of routes. We're focused solely on leisure passengers during periods of peak demand when really that demand exceeds the supply of aircraft. It's hard to compete against this model because of the way we schedule. So as I said, we're moving the aircraft around to 2 points when we can maximize fares because demand is really high. So capacity is already high in those markets. Demand is just higher. If you know about Allegiant at all, our scheduling strategy is -- we fly to big cities. They fly to smaller cities. But the strategy of in and out of markets peak demand is similar.

Yes. And obviously, I think the next panel here will be talking about a pretty big merger, but how do you look at M&A in the industry? I know you guys are a smaller airline, a couple of start-ups out there, Avelo, I think, with somewhat of a similar strategy. What's the future look like? Are we going to have more and more airlines? Or is there M&A still to come?

In my view, the answer is probably both. In other words, there's going to be M&A. There should be consolidation in our view, and you're going to have these start-ups that sort of come along. The more -- consolidation is good for the industry. I think it's provide some capacity discipline, allows cost to be taken out. So we're pro consolidation, and I think there should be more. We'll see if it could happen from a regulatory perspective, but we're supportive of that.

Okay. On the cost front, you guys run a pretty low-cost operation. We touched on this a little bit earlier. Just remind me, did you guide to a 2022 CASM ex fuel?

We gave a broad CASM guide for 2022. So even with our new pilot deal, we expect our 2022 CASM to be a little bit below what it was in 2019. So unlike a lot of other carriers who are seeing big unit cost increases, we should be a little bit below what we were just pre pandemic. In '23, we -- our objective is to have a CASM below $0.06. So going to continue that trend downward.

I mean this is pretty impressive results. Can you talk to how are you achieving this?

Yes. Again, I mean, a lot of it is sort of leveraging growth. The dividends -- we -- our fleet strategy is mid-life 737s. We have a very active program of buying greentime engines to avoid expensive overhauls. We manage the fleet very tightly. The 737 market -- sorry, the 737NG market has been really good for buyers. Not only did the pandemic results in a lot of used aircraft being put on the ground, but now with the resumption of 737 MAX deliveries. There's a big supply of aircraft. So we're able to get aircraft at very competitive prices, and we operate them for -- till the end of their useful life, really.

Yes. And we just saw you compare Allegiant place an order with Boeing for the MAX. And obviously, they have a larger fleet, larger operation. But part of their justification is the fuel burn, the fuel efficiency of the new engines is pretty significant. I mean is that something you guys will look at in the future? Or do you think used fits your model better?

We're driven by the economics. So we've looked at a number of potential MAX deals before. The problem is the math for us doesn't work. The increased ownership cost associated with the new MAX versus the lower costs of the aircraft we buy today. That increase is more than the operational fuel burn savings. So just the math just doesn't work and it's really not that close. One of the things when you get to a certain size, I don't know if it's 100 aircraft or what it is, but it becomes more and more difficult to grow with simply used aircraft. And my presumption is that's what sort of they're probably seeing there because you have to source a significant number of disparate aircraft every year just to keep up with a certain percentage growth rate. That's not easy to do. So at some point, it makes logical sense to go and buy new aircraft. We're far from that point right now.

Yes. And we're hearing across this conference, the aftermarket and aerospace is picking up quite a bit. I think you guys did say on your call, you sourced what, 6 or 7 aircraft for this year already?

Yes. Our growth plan for 2022 is 8 aircraft, of which we have 7 scheduled at this point to come in. So we really got to find just one more plane, which is not an issue for this year, and the pipeline is very strong. So our growth from a fleet perspective, we're highly confident we're going to be able to achieve.

And how have used aircraft values trended? I mean is this...

They haven't moved very much for us. I mean we've looked at hundreds, literally hundreds of aircraft over the last 2 years to get 15 or so, 15 or 20. The pricing work -- a recent deal we just did, the pricing is just as competitive as deals we did in early 2021, late 2020. So so far, the market is strong. I think you probably had a lot of lessors may be holding on to these older aircraft coming out of the pandemic or during the pandemic, believing they were going to be able to place them when growth resumed. Maybe that hasn't played out the same so there's lessor selling aircraft, there's plenty of planes around.

Okay. Any questions from the audience? Okay. Can you talk about your pricing strategy in ancillary?

Yes. So essentially -- let me just back up for a minute. So we really transformed this airline beginning in 2018. And the airline used to be relatively low density. It had a first-class section. It really was, for whatever reason, sort of a competitor with Delta or tried to be. We went in and basically replaced all the interiors to a higher-density configuration, brought average fares down significantly and started to focus on ancillary revenue production. Our ancillary has been up substantially, like from the 20s per passenger to now 44-ish per passenger. It was what we expect this year. We think there's probably another $5 of upside in that. And it's really through a lot of the standard ancillary categories you think of, bags, seats, some change fees, although that's been much less recently. And we think there's more room to go. So we're very focused on ancillary. It's been a huge success for us, and it's worked so far.

And what about like vacation products and third party?

Yes, that's sort of probably the next frontier for us. We made a big system change in 2019. We changed our entire point-of-sale res system. We had an interruption in our ability to sell vacation packages as a result of that systems change. We basically remedied that and fixed it. So I think probably the next leg of ancillary growth, at least a major component of it is third-party sales. So it's packaging, rental cars, hotels, packaging, these things together, that's to come in the future.

And Jude obviously came from Allegiant where they do that pretty well. I mean what's the opportunity from a profit perspective on those types of products?

If managed -- if it's managed properly, it can be a very profitable business. What we're not going to get into is heavily discounting airfares in order to sort of subsidize a vacation package for someone. It's through good hotel deals, through the right packages, through the right deals with rental car companies that this is going to work for us. And so far, it's -- the steps that we've taken so far have been really successful. We think there's sort of more to go.

Okay. And I guess on the capital side, with the acquiring used aircraft, from a financing perspective, what are you doing? Are you raising debt or cash? Or what's preferred...

We've been -- we've paid cash for the last few aircraft. The next couple of aircraft we take, we'll probably pay cash for as well. But when we get a critical mass of aircraft, which we're close to, we'll flip it into a facility. So we are in the process of putting together our second EETC, which we hope to get done by the end of the first quarter. Even with increases in interest rates, it's a very attractive financing for us. We'll settle for relatively lower LTV than we would have in the past just because of the strength of our balance sheet and the amount of cash we have. But we'll -- we think we have plenty of access to capital markets, and we'll continue to sort of finance these aircraft as we take them.

I guess what's your ideal leverage ratio then?

I guess I don't have one. I mean our leverage ratio is below 2 at this point. If I look at sort of our 4- or 5-year plan, it essentially goes negative as I have more cash than I do debt on the balance sheet. I mean that's with paying cash for a number of the airplanes. There's some healthy level of debt. I would say if we stay below 2, we're just fine. We have a very strong balance sheet, but we may naturally trend lower than that.

Yes. I mean that might be smart because it seems every 10 years, this industry goes through a pretty rough patch so...

Exactly. Taking on high debt in a cyclical capital-intensive industry is not a formula for a long-term, long-term viability.

Yes. And I guess we're running out of time here, but can you talk to your frequent flyer program because that's become quite profitable for the larger carriers? Is that something you guys are emulating as well?

We totally, we did our loyalty program a couple of years ago. It's a much more basic sort of points for dollars. So you fly, you get points and then you can use those points to pay for airfare. It's been -- it's worked really well. The thing that's worked the best about it is our credit, is the credit card stuff we've done. So our credit card applications have been up dramatically really over the last 12, 15 months now. So it's an inexpensive loyalty program, highly profitable. Our travelers are not -- they're not road warriors. You know what I mean? They're families who go on vacations and fly once a year, twice a year kind of a thing. So loyalty program is sort of less important than it would be for Delta, for instance. We have a simple program that sort of fits our needs.

All right. Well, Dave, we're running out of time here, but I really appreciate you coming down first time at the conference.

Sounds good.

And it's been a fun time.

Thanks, Brandon.