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

Okay. So several years ago, I invited -- I mean, really, several years ago was when Robert Ashcroft was still doing Investor Relations for Allegiant. I asked Allegiant to come to our transport conference, and their response was, "Well, you don't cover us." Okay. It's a fair point. So you can imagine how pleased I was this year when we reached out to Sun Country, which, technically, I don't cover at the moment. And they were more than happy to come and take our stage and share that story with us, for which I'm very appreciative. So Bill Trousdale, the Treasurer, is going to be joining on stage. And let me turn it over to the CFO, Dave Davis, of Sun Country Airlines.

Thanks, [ Jamie ].

Thank you.

Thanks all for coming to our late-in-the-day presentation. We appreciate it, and thanks to the JPMorgan guys for having us. A lot of people are probably new to the Sun Country story. We've only been public now for about a year. We think we have a highly differentiated model, significantly different from other carriers. The profitability that we've shown not only in 2021 but also in 2020 during COVID we think is pretty unique in the industry. So we'd like to walk you sort of through our story and then take any questions that you have. So let me give you a little bit of an overview of our business and sort of what makes us unique. So we operate across 3 different business segments. Across all those different business segments, we use the same type of aircraft, 737-800s. Our pilots move seamlessly between all 3 segments. Our passenger aircraft move seamlessly between our charter and our scheduled service segments, and we share resources across all 3. But essentially, the 3 business segments we have, our largest is our scheduled service, so basically passengers buying tickets and flying around. Our biggest operation is centered in Minneapolis-St. Paul, where we are the second-largest carrier behind Delta. That's about 60% of our revenue or so is our scheduled service business. We also have a charter business. Folks basically charter our aircraft the exact same interior configuration that we have on the scheduled service business, so we can move the aircraft around, schedule them seamlessly between each other. It's about 20% of our revenue. And then we also have a cargo business. Our cargo business has 1 customer. It's Amazon. We fly 12 dedicated 737-800 freighters for Amazon, again, using the same resources, the same pilots that we use in the rest of our business segments. There are several unique things about our model. One is the segmented approach that we have. Two is our ability to sort of move resources around, really importantly, particularly today and sort of in small print-up here because we did this chart a while back. But about 1/3 of our total block hours, we don't have any fuel costs for. So in our cargo segment, which is highly profitable, Amazon pays for all of the fuel. In our charter segment, our charter customers pay for the fuel. So about 1/3 of our fuel exposure is essentially naturally hedged. We've been growing rapidly. Our history is basically the company is quite old, formed in the '80s. It was taken private -- or it was private, but it was purchased by Apollo Global Management in 2018. That's when essentially the new management team roughly came onboard, and we've transformed the airline and grew it significantly since then. We started the year with 36 passenger planes, 12 cargo aircraft. We're taking deliveries on a monthly basis here. By the end of this year, we'll have 44 passenger aircraft and 12 cargo aircraft and significant growth plans from there. This is a picture of our route network. I'll talk about sort of the unique aspects of our scheduled service business in a minute, but it's Minneapolis is our largest operation, then we do point-to-point service at peak times of the year around the country. We have no long-haul international exposure. All of our business is 100% leisure. It's domestic and short-haul international. So Mexico and the Caribbean is basically where we fly. Something super unique about the business, hard for others to duplicate, particularly with our 3-segment approach, is the way we schedule our scheduled service business. So a little complicated, but this graph here on -- I think it's on your left. The orange line is -- are the number of seats that we have scheduled at any month in the year. You can see how much it varies from month-to-month. That's because our focus is we fly in locations, we fly at times of year, we fly on days of week when demand is strongest and we can maximize unit revenue. Then we're out of those markets or flying much less frequency when the demand isn't there and we can't maximize unit revenue. During those down periods of time, our pilots are either flying cargo or we have our charter operation picking up a lot of block hours. So it's our scheduled service approach allows us to maximize unit revenue across multi segments. We can keep asset utilization very high. The other 2 lines there are low-cost competitors, Spirit and Frontier. Their model is extremely low cost, so they need to fly a very flat schedule that keeps aircraft utilization very high, which means they're flying at times of year, days of week when demand is less strong, so the unit revenues also suffer. Since, really, we got sort of started here, we've been -- had a significant focus on driving ancillary revenue. So we've basically doubled our ancillary revenue from 2018 to today. We think we have probably $5 of upside per passenger to go here. This is exactly that you'd expect bag fees, seat fees, that kind of stuff. We have a number of initiatives to continue this highly profitable growth that we've had. We are looking at more bundled products, so offering bags, seats, change fees, all the stuff and bundles, which we don't do today. We have some tools we're building to yield manage our seat assignments. So when there's fewer better seats, best seats, we charge more for them, sort of basic tools, which we haven't put in place yet, which will allow us to continue to drive this number higher. Our charter business is -- really, we have the second-highest market share in the U.S. now for narrow-body charters. Our charter revenue per block hour is averaged about $8,800. We took a dip during COVID, and we're well on the way to recovering there. We are the only scheduled passenger airline with a meaningful charter business. It's a significant portion of our revenue in the U.S. The really important thing is this business, as I said before, is scheduled seamlessly with our passenger business. So we could have an aircraft flying, let's say, scheduled service, Minneapolis to Las Vegas on a Thursday. That aircraft will sit there on a Saturday. It will fly a charter flight up and down the West Coast, come back to Vegas and then fly a scheduled service flight from Vegas back to Minneapolis. So we're fungible between segments. Same pilots operate the entire trip. We keep our asset utilization high, our unit costs low and able to pick up and peak that -- the kind of revenue that we're going after. I mentioned before, we have pass-through fuel costs in these segments, and the business is largely insulated from economic cycles. The people we fly around are the U.S. military. We have -- we are the charter provider for Major League Soccer. We have casino business. So it's a very sticky business that continues to operate in good times and bad from an economic perspective. And then you add on top of this, our stable cargo business. So we signed a deal with Amazon in December of 2019, just pre-COVID. We started flying for Amazon with 2 aircraft in May of 2020. By November of 2020, we had ramped that to 12 dedicated freighters, and that's where we are right now. The business is highly complementary. Not only is it profitable, but it provides a very stable base, predictable base of flying between the same city pairs very regularly, which offers a sort of stable base to our highly peaked scheduled service business. We have a 10-year contract with Amazon, 6 years and 2, 2-year renewals. We're, I guess, about 1.5 years into that or so. So we've got a long runway to go. Since we signed this deal with Amazon, all of their North American narrow-body freighters have come to us. So we think they're pleased with our performance, and we're really happy to have this business. One of the things -- this slide here is a little bit complicated, but I think it shows why we are pretty resistant to competition and how these 3 segments work together. Basically, what these large numbers represent is the variability of the business, so the variation in daily block hours from 1 day to the next. So again, it's a very peaked approach. It means that our scheduled service business, there's like a 44% differential on average between the block hours we fly from 1 day to another. Fully utilized on, let's say, a Thursday at the end of March, a bunch of aircraft parked on a Tuesday in September. So it's very all over the map. Typically, that would mean -- that would mean very low levels of asset utilization, but we're able to keep it high because of these other segments. So our cargo business, as I talked about, very stable, a stable underlying base of flying, very low volatility. Our charter business has high volatility, but it's largely countercyclical to our scheduled service business. So we fill in valleys in the scheduled service business with charter flying. What that tends to do is dampen the overall variability of the airline, keeping our asset utilization high and our unit costs low. So we think this is a strong barrier to entry for us. This unit revenue-maximizing approach really only works if you have these other segments that you -- where you can utilize the assets to keep unit costs down as well. This is the secret sauce of the model and what our whole objective is. So we want to generate above-average unit revenue and keep our unit costs probably slightly higher than the other low-cost competitor comparisons who fly this very, very high utilization model. So I think this is 2021. Our unit revenue was $0.0912, higher than our competitors. Our CASM, a little bit higher and on the way down, but it's that differential that we're trying to maximize. So if you look at the 2 most profitable carriers in the industry, it's us and Allegiant, we both sort of have this model of targeting our capacity to periods of high demand and not flying when demand is low. So far, it's worked for us since we got started at this. I'll talk for a minute about our costs. But unlike other airlines, our costs are on the way down, not on the way up, despite the fact that we just signed a new pilot agreement. Talk about on this slide. So the blue bars are the CASM for our company. So in 2017, it was $0.078, dropping drastically between '18, '19. In COVID, we all took a hit, so our CASM was a bit higher. This year, we're looking at -- sorry, last year, we looked at $0.0644. This year, we anticipate our CASM being consistent with our CASM in 2019 despite sort of a lot of the cost pressure that's out there. And we think in 2023, we can drive our CASM to a sub-$0.06 number. So we can maintain these high unit revenues, keep our CASM moving down. Talk more about in a minute where sort of that comes from. So I think there's probably been a lot of talk at the conference about labor deals, labor shortages, all that kind of stuff. We had a significant issue from a pilot perspective late last year. So in the fourth quarter of 2021, we started to see applications tail off and attrition spike. The pilot contract we've been operating under was negotiated probably in 2013 or 2014, was about 40% lower than the industry. So we had pilots leaving as legacies and others were ramping up hiring. We approached our pilots in and about a 3-month period. We negotiated a whole new pilot deal. For those of you who have done these deals before, I've never done one that lasted less than 2 years. So we did it in sort of lightning speed. We brought our pilots up to slightly higher pay rates than Spirit and Frontier. Since then, our applications have been up about 160% versus the pre-deal period, and our attrition has moderated dramatically. So we're able to fill our classes, get the pilots we need to drive the growth that we have planned. The result of this, since we were so far behind the industry, was about a 34% increase in our pilot cost per block hour between 2021 and 2022. The good news is that we were able to offset almost this entire cost increase elsewhere on the P&L. So our total cost per block hour, which is an important metric for us on a per block hour basis, is up only 2% year-over-year and, in fact, is below our 2019 cost per block hour. So we've been -- we're very cost-focused at the company. We've been laser-focused on getting our aircraft ownership costs down. We've converted almost our entire fleet to an owned model where we manage the maintenance program. We target exclusively midlife 737-800s. We have no order book. We source things on the used market, bring them in, conform the aircraft, put our interiors in and add them to the fleet. We manage these maintenance programs very aggressively. So we buy green-time engines, do things like that, to avoid overhauls. We've been able to drive our aircraft ownership costs down about 25% since 2017 on a unit basis. We've also had a lot of luck at reducing our distribution costs. We've driven more and more of our business direct through our website. About 70% of our business is now either through our website or through our call centers, so the lowest-cost approach to distribution. And we've been able to sort of leverage growth. So as a result, we're keeping our costs in line despite the new pilot deal. Our competitors are entering into a period of new labor deals in the next couple of years. So we think we're going to get a cost halo again as they sign deals in the years ahead and we have a deal which is now done and ratified and in place for another 4 years. Another important thing about this deal. We had some provisions in our pilot contract that made it difficult for us to grow with Amazon, particularly related to where we could put reserve pilots. We got that fixed in the new deal, which we think opens the door to additional Amazon growth in the months and years ahead. Talk a little bit about growth. So we have growth planned really across all 3 segments. This just represents the number of average daily round trips in the blue in Minneapolis and in the orange, non-Minneapolis. Part of the reason the non-Minneapolis average is so low is because of the scheduling approach that I said, so heavy flying outside of Minneapolis at peak periods. LAX-Honolulu is a great example, one of our most profitable routes. We fly June, July, August, and we're out of that market. But if you look at an average over a year on a daily basis, it's small because we're not in these markets when they're not profitable. Minneapolis is a little more steady, but this is roughly our growth plan between now and 2025. So we think there's more growth for us at Minneapolis. I'll talk in a minute about our market share and significant growth for us outside of Minneapolis as well in the years ahead. This is our market share in Minneapolis. So the orange bar is Sun Country. Our 2021 share of the market is 18%. We're the second-largest carrier there. Delta is actually also growing market share in recent years. They're at 58%. The share of Delta and us together has grown at the expense of all the other carriers in the market who essentially shrank there significantly in the last 3 or 4 years. So this is quickly becoming a 2-carrier market, us and Delta; us focused purely on leisure, purely peak demand. Other areas of growth for us on the scheduled service side, in addition to just sort of high unit revenue markets around the country. We're growing more in the Upper Midwest where our brand is more well-known. So we're adding frequencies out of Milwaukee, adding frequencies out of Madison, Wisconsin. Other near -- other states near Minnesota are seeing significant growth really in the months ahead. Charter flying, this has been a great story for us in the last few years. What this shows, in 2019, our average -- our total charter block hours was about 20,000. The breakdown between blue and orange is blue is the amount of business under contract, so predictable business under contract. The orange is ad hoc business that we pick up a few weeks ahead of time. I think the U.S. military who bids out stuff, we bid on it, and we fly it. During COVID, that ad hoc business pulled back significantly. The U.S. military flew less. There were other carriers in that market who weren't there before because there wasn't demand elsewhere. So it got smaller for us. We backfilled all of that with essentially long-term contracted business. So between 2019 and 2022, our contracted business on the charter front is up about 150%. I mentioned a couple of the big new contracts we have, MLS, Caesars, there are others as well that we're not doing flying for. Just the return of that ad hoc business, as the military comes back, college sports rebound to their full potential. There's natural growth built-in just if we get back to our prior share of the ad hoc business over the next couple of years to say nothing of more fleet growth in other markets that we're pursuing. This is just our market share over the years. So we started off a relatively small player, 10% of the market. We're now the second-largest narrow-body charter carrier in the U.S. iAero used to be called Swift, dedicated charter carrier, they're the only ones larger than us. And then the third segment of the business is Amazon. We don't control Amazon's growth, obviously. They do. As I said before, we're at 12 freighters. I think everybody knows how quickly the company is growing, how quickly their shipping needs are growing. So we are confident that as Amazon adds narrow-bodies to their domestic fleet, we hope to participate in that. We think we're a high-reliability carrier. We think we're viewed favorably by the company, and we'll likely see more growth here in the years ahead. This is just our growth trajectory. So I talked about us starting the year of 2022 with 36 passenger planes, 12 cargo planes. By the end of '23, we should be up to 50 aircraft on the passenger side and then adding 5 to 8 aircraft a year after that. Our goal is to grow by 8 aircraft this year in 2022, of which we've already identified 7. Those are coming onboard here in recent months. So we'll get everything we need in 2022, and we're at work on 2023 to find the aircraft that we need as well. As I said before, we focus on midlife 737s. There's been some questions and talk about sort of that market tightening. We haven't seen tightening. We have a very disciplined approach for valuing aircraft. We look at the value of the -- of a run-out airframe and engines. We had embedded maintenance value. We had an age premium. That's what we think the target price is for an aircraft. We've been pretty consistently being able to get the number that we think is the embedded value in the aircraft, and that hasn't changed that much in recent months. I think the ramp-up in Max deliveries have accelerated some 737 NG retirements that have kept the supply steady. But we have no order book, no big commitments, no calls on our capital in the months ahead. We can grow as rapidly as we want to. Let me talk a little bit about financials. So this was our 2021 profitability. We just showed everything on an EBITDAR basis. We were at almost 20%. We had an operating margin of about 10%. Allegiant was a little bit behind us in 2021, and then you can see the rest of the carriers there. So we were consistently profitable in '21. This was our -- a look at our 2020 numbers. So we generated an EBITDAR, a positive EBITDAR margin during COVID. Again, it has to do with the flexibility of our scheduling and not flying when demand isn't there, the stability of our cargo business and the stability of our charter business. Our balance sheet, as I mentioned before, we went public in March of '21. We added significant cash to the balance sheet. So the airline has very significant levels of cash. The uses for that cash at this point any way are to fund our growth. You can see the free cash flow bars were solidly free cash flow positive from what we can find. We're the sole positive free cash flow airline in the U.S. in 2021. We were strong, and so we anticipate that continuing as we move forward into '22 here. So strong cash balance to begin with. We're generating a lot of cash, and we're buying low-cost aircraft to grow. So we think we've got a unique, highly profitable business model. Our net debt to adjusted EBITDAR is -- in 2021 was sub-2. This will keep trending down. The only debt we have on our balance sheet is some aircraft debt. We have no other debt that we need to deal with. We, actually, during COVID reduced the amount of leverage on our balance sheet. We didn't increase it. We reduced it. We were able to get through the year without any additional cash from our private equity sponsor, just on our own steam with Amazon and others with that piece of business. We took on a little CARES Act loan, very small, $45 million, at the end of '20. We paid that back as soon as we went public. So by the time COVID was essentially in the rearview mirror, we had actually had less debt than when we started. So we think our balance sheet and our free cash flow positions us really, really well for the future. And that is it.

Thank you. Very thorough. So help me think about growth in the cargo and the charter business. Do you have any control over that? It's presumably with fuel being a pass-through, I would imagine a higher margin than the traditional passenger service. How do you grow it? Do you just have to wait for deals -- for RFPs and then you bid and perhaps receive it? I mean are you in control of that sort of destiny, for lack of a better term?

So let me take those segment at a time. The way we grow the cargo business is by being very reliable because our customers' most important -- the thing they look at above all else is, are you reliable? We think we are extremely reliable for Amazon. I don't know exactly what the stats are from other airlines, but we're highly confident that we -- that they're pleased with us on that aspect. So we think our growth there is dependent on how quickly Amazon grows their narrow-body fleet. So we're not in direct control of it. We don't have an intention right now of going out and seeking other cargo business. We're not going to develop a marketing arm and go out and try to sell belly space and all this kind of stuff.

Are you prohibited from doing so? Or are you...

We are not. We are not. It's just not a focus -- maybe it will be at some point, but it's not right now. The charter business is interesting. There are more long-term deals for us to pursue. Things like MLS, we just started flying for one-off. We turned that into a 5-year contract. Caesars, we used to fly for them, then the business got lost. It's come back to us at double. So there's more pursuit of that kind of long-term stuff that we can absolutely go after. But one of the biggest areas of growth there is on the ad hoc side. We have -- we haven't had the pilot resources to pursue that to the level that we want to pursue it. So let's say, March, for instance. Historically, this airline was the largest charter carrier for March Madness, for college basketball. We're not doing it this year. The reason -- we want to do it. The reason we're not doing it is because we're utilizing every pilot we have, all the aircraft we have in our scheduled service business to meet demand. As we ramp up with our pilots -- remember, we signed this deal in December of '21. As we ramp up, we'll have more resource to be able to pursue that stuff. So I think growth in these segments, particularly the charter side, is very much in our control.

Got it. Yes, go ahead.

Well, I want to jump in. We can share. On the used aircraft market, what are you seeing in terms of availability and so forth and you're willing -- your ability to get what you want in terms and whether the market has bounced off the bottom? Just any clarity you can give us on the deals you're cutting today. Are they better than, worse than, same than the deals you were cutting 3 months ago, for example? Because there's a lot of noise in Russia, but we were starting to sense that the market had bottomed out and that prices were starting to firm up. But maybe you can confirm or deny that.

That's a good question. This is sort of the dynamic. The short answer is we haven't seen that much change. So I talked a minute ago about how we value aircraft very much bottoms up. We just did a deal for 4 x Norwegian 737s. The place on that sort of value curve where that deal sits is about the same as deals we did 12 to 15 months ago. So we're still getting the aircraft we need at the prices we want. I think the dynamic that we've observed is sort of in COVID, there seemed to be some reluctance, maybe among lessors and others, to sell aircraft under the belief that the world was going to return very quickly. When it didn't return very quickly, I think we saw some softening of that, some more aircraft availability. And then in recent months, with Max deliveries ramping, there's a lot of aircraft on the market. So I mean, we have looked at, in the last 6 months, probably 150 planes. We got 8. The sweet spot for us is 8- to 12-year-old 737 NGs, the 800s. There's 1,700 of them that were built in that period. So the pool is deep. If we broaden that out, there's over 4,000 of those aircraft types that are out there flying around. So the pool for us is very deep. When you're looking for 7, 8, 9 of these a year, we're still getting the deals that we want.

On the pilot issue, you explained well the catalysts for the increase. But I was a little puzzled. I mean I get your point in saying that Spirit and Frontier and some other discounters, probably Eclipse, you're right, but doesn't that just imply that you'll be in the same situation where you then have to worry about attrition? Or do you think the work-life balances and improvements you made were sufficient?

I think we have some built-in advantages. I think the Minneapolis space is a big deal, and we have a lot of interested people who want to be there and the first officers with the line instead of sitting in JFK and flying reserve. So I think there's some built-in advantages to us as well. I think this halo -- realistically, by the time these other guys start negotiating contracts and there are probably 2- to 3-year periods before those get done, I think were probably 3 to 4 years before those contracts are finished. I think that this sort of pilot hiring issue, there is a systematic problem. There's not enough people going into the piloting world. That's going to persist until more young people decide they want to be pilots. But there's also a big cyclical aspect to it, in my view, which is legacies and others offering big retirement packages in 2020, many, many pilots leaving, now a quick ramp in massive hiring. That cyclical piece, I think, eases over the next couple of years. So hopefully, we're not in the same boat again 2 years from now because, hopefully, the problem has alleviated itself a bit.

Okay. And I'm surprised, do you not see more international growth opportunities on the scheduled service side? Or is that a range capability issue of the 800?

There are more opportunities in the Caribbean and Mexico for us. I mean our biggest markets are Fort Myers. So many Fort Myers is probably our largest market. In the winter, we do 6 to 7 dailies between those 2 markets. Cancun is a close second. We recently added Providenciales, a couple of other cities in the Caribbean that have all done extremely well. So yes, there's growth there. Our -- the limiter for our airline is not market opportunities. It's getting the people in place to be able to sort of meet all the market opportunities that are out there. That's what we're focused on doing, but there's plenty of destinations for us to fly profitably.

Questions from the audience? So bear with me for a second. Years ago, in a prior life, I worked for Mike Levine at Northwest. And that influenced some of how I think about the airline industry today. And one of the things that Mike was -- an observation that he made was that hubs tend to work best when you have 1.5 airlines. Once you try to have 2 airlines with commensurate market share, you run into problems, as the world has seen in Tokyo, in Chicago O'Hare in Heathrow and what have you. Do you ascribe to that sort of 1.5 carrier per hub concept, recognizing that you may never have even heard the idea before? I mean this was 25 years ago.

I worked with Mike for a long time in Northwest.

See, I did not realize that.

Yes, I did.

See, I covered you.

Yes, exactly. Exactly. Yes, yes, yes.

I saved the 2 airlines that I don't cover until the end of the day. And then -- so how do you...

I think that's exactly right that a hub with 2 network carriers on it with equal market shares is not a formula for extreme profitability. That's not Minneapolis, and that's not us. We are not going to be as big as Delta. We are not trying to compete directly with Delta. We joke that if we see any business passengers in our terminal, we direct them over to Delta. We're not trying to -- our schedule is completely not conducive to the business passenger who asks to get from A to B on a Tuesday. So we think we sort of work fairly well together. We stay out of their hair. We serve 1 passenger segment. It's leisure passengers at given times of the year. So maybe the 1.5 thing is exactly right then being on us being half.

Yes. Okay. All right. Anything else, [ Mark ]? Anything we should be asking you? You probably have one of the more thorough presentations of the entire day, quite frankly.

I mean I think folks hopefully sort of understand the story. What -- I think we're very unique. And I think we've had difficulty sort of getting that differentiated unique story out there. I think we're unique and hard to duplicate. The results that we posted and that we've shown even in the worst times in the industry's history, we think sort of bear that out. So you can just watch our performance in the months and years ahead, but we think we've got a very unique story.

All right. Sounds good. Thanks so much for being part of it. Appreciate it.