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

Moving right along in the morning program. Next up, we have Sun Country Airlines and their CFO, Dave Davis. Dave, thanks for joining us today and coming out and supporting the conference.

Thanks for having me. I appreciate it.

Absolutely. So clearly, the focus of investors these days top of mind, obviously, the demand environment, right? We had a larger network carrier last night put out some pretty good, revised guidance talking about good demand kind of across the spectrum. I guess from Sun Country's perspective, how do you respond -- the equity markets are clearly saying there's something else going on out there? I guess how do you respond to the markets and really all the concerns about the ability for the consumer to keep up their current travel trends, just given all the inflation out there and the impact on consumers' wallet. Curious to get your thoughts on that.

Yes. I mean, so demand for us, we're kind of seeing probably what everybody else is seeing in terms of trends, maybe even a little bit better. We gave second quarter guidance of unit revenues of 25% to 35%. So we're seeing that demand continue right up through yesterday. I mean, bookings remain very strong. Average fares remain very, very high. So we haven't seen any slowdown at all right through the summer booking months. I mean, clearly, it's a function of not only the consumer but maybe somewhat unique capacity constraints that are in place right now in the industry driven by other factors, where I'm sure we'll talk about operational pilots and that kind of thing that are constraining supply, which is having an impact on unit revenue. So do I think it's going to be consistently 25% to 35% up forever? Probably not, but I think it's going to remain a very strong revenue environment, just given what's happening both on the demand side as well as the supply side.

And in that environment, you've now seen this kind of really strong demand, call it, I'd say, we've started seeing it in our data mid to end of February as kind of Omicron really began to fade and you start to see some -- you had some of those operational challenges. Do you see yourselves like having to like learn and manage your inventory differently, kind of maybe try not to sell out too far in advance, hold some more closer in. Is there anything that you're seeing like changing in that regard?

Yes. Yes. And it's exactly what you just said. So like the bookings that we're taking right now for the summer months are substantially higher than the bookings we took for those same flights a month or 2 back. So the -- what we've been doing is basically holding inventory, keeping capacity open and not closing off fare buckets knowing that we're going to continue to pick up higher and higher fares.

Absolutely. Yes. So I guess from your call, really, a few things continue to kind of stand out to me from -- for Sun Country. You continue to be -- you're profitable, just even through Omicron, higher fuel. Obviously, you're seeing the strong demand that everyone else is seeing and you're doing this despite going up against really large kind of legacy competitor in your biggest market. Can you maybe take a step back and kind of explain kind of what makes Sun Country unique versus other airlines and maybe particularly against your kind of ultra-low-cost competition?

Yes. So I mean the airline is pretty truly unique, at least in the U.S., for sure. We operate across 3 different business segments. We have a scheduled service business, which is our largest. Then we have a charter business, which is basically as it sounds, we basically fly charter aircraft around -- charter flights around. And then we have a cargo business which consists of 12 aircraft that we fly exclusively for Amazon. Across all 3 of those segments, we cross utilize a lot of our resources. So it's the same pilots who fly in the charter, who fly in cargo, who fly in scheduled service. So unlike others, we sort of have multiple segments to spread our costs over and a change in any one segment is sort of less disruptive to us than it would be if we were solely dependent on one segment. We also share aircraft between the passenger -- between the scheduled service and the charter services. So there's the same interior configuration. You can be flying a charter mission one leg and then transition to a scheduled service leg the next. So what we do on the scheduled service side is we have a very peaked scheduling approach. In other words, we are in and out of markets quickly. We're in and out of different places at different days of the week, depending on when unit revenues are the highest. So we fly when the unit revenues are there to capture, and we're not in those markets or flying on those days when the unit revenue isn't there. So our fleet will be flying hard, fully utilized on, let's say, Thursdays through the weekend into Sundays. And on Tuesday, a portion of our fleet is parked because the leisure demand just isn't there on Tuesday.

It's just [ low yielding ].

Yes. So typically, that would result in very low aircraft utilization. If we follow that pattern, we're able to solve some of that because we also have a charter business, which would fly in when seasons -- when demand is particularly low on the scheduled service side. So it's very unique in that it's not like other ULCCs where we have to maintain 12 hours of flying a day to keep our unit cost very low, our unit costs are a little bit higher than the Spirits and Frontiers, but our unit revenue was substantially higher as well.

On the Charter business, I imagine it's a lot of sports teams and things like that. What are the other customers in charter? And I guess how far out is that typically booked on, I would assume it's a lot further out than any sort of scheduled airline service. So you have a bit more visibility into that? Or..

Yes. So our -- there's really -- if you can segment it in a couple of different ways. There is an ad hoc business and there is a, let's call it, a contract business. The ad hoc businesses where on a monthly basis, you will be bidding for certain charter flights. Some examples of that would be the military business, where there might -- the military is going to put up a bid to fly troops from point x to point y., we have been on that sports, for instance, college football during the [ Ball ] season that last minute stuff who's going to go where. Then there's a contract business, which is becoming more and more a part of our charter business. So we have a charter contract with MLS, we provide the charter flying for Major League Soccer. We do a bunch of casino flying, whether it's for Caesars, for Riverside, for others, where we fly basically casino business under a long-term contract. So it really varies. The advantage of the contract business is we know it well in advance. We can schedule our pilots to be able to fly seamlessly between different segments, and we can schedule far in advance, which means it's more efficient.

Got it. And the cargo business, with the 12 freighters, are you on specific routes? Or do you go just based on where the demand is, how do you run that?

We go where Amazon tells us to go basically. So It's a...

[indiscernible].

Yes, exactly. It's a great business for us because it's asset-light. Amazon owns the aircraft. They are responsible for obviously for filling the aircraft because it's their business. They're responsible for the loading and unloading of the aircraft. We provide the pilots and the maintenance there. We just fly it. So we get a new schedule from them periodically. A lot of it is the same, but we fly where they tell us. So it's basically between Amazon distribution centers.

Yes. Got it. Okay. In a lot of ways you're different than your competition and in other ways, you're similar. You've been trimming capacity like others have kind of what are your biggest operational headwinds these days and some of the reasons for those capacity cuts?

So I mean, the fuel environment is obviously high. So we would be trimming some of our scheduled service capacity regardless because of the fuel costs. Our most marginal flying would make less sense. The main driver of our capacity right now is pilot availability, which I think is the case with a lot of others. We have -- we've been growing very rapidly. So we were about 30% bigger on a block hour basis in the first quarter of '22 than we were in the first quarter of '19, and that's the sort of growth rate we've been at. So there's a lot of pilots required to sustain that growth. We signed a new pilot agreement in December of last year of '21, which has resulted in a step-up increase in applicants. So we have sort of a lot of applicants coming in, which is great because it's one of the biggest problems that some others are facing. The problem for us right now is, as I've heard from others, is the training pipeline. And that is being able to expand the size of that pipeline to be able to increase our new hire classes and offset what continues to be a little bit higher-than-normal attrition rate. So it's no secret that when legacy carriers are hiring, they're going after regionals. They're also going after some of the low-cost carriers. That's where their pilots come from. So that results in a higher attrition rate, which we have little control over. The way to combat that is to be able to bring more pilots in, get them on the line and that requires us...

You have that.

That requires us to have the bigger training pipeline. We've taken our new hire classes up from about 12 a month to 20 a month, we want to go to 30 a month over the next 4 or 5 months.

And where does attrition stand right now? Is it kind of pushing double -- around double digits? It seems like that's where people are...

Yes. So we had a high rate of attrition in the fourth quarter. We then signed a new pilot deal that dropped but it hasn't dropped to the level of sort of that it was pre-pilot deal that remains a little bit elevated. Over the last 4 weeks, it's dropped a lot. Our attrition has dropped a lot. I can speculate -- my speculation, and this may or may not just probably easily confirmable. But maybe there's a pause at some of the legacy carriers in hiring because their training pipeline is so chockful, they're just bringing in more people at the front end probably doesn't make a lot of sense until they can work through that. That may be part of it. The other thing that may be the case with us is we had pilots in the pipeline who were going to attrit before the new deal was signed, and now they're not going to. Now those have sort of worked their way through and so there's a structural reduction in attrition. But in any case, between moderated attrition, significantly higher pilot class sizes, we should be able to get back on the growth track we want to be on in '23. But our main limit right now [ pilot ] availability.

And the attrition that you're seeing, is that mainly in the first officer [ ranks ].

Yes. It's -- I mean a captain here and there, but it's people who've been at the airline for 1 to 4 years.

And how long does it take a new first officer to become Captain?

It could happen relatively quickly with us because of the growth rate -- in 3 years.

Okay. Okay. Just wanted to touch upon -- you said you would have been trimming capacity anyway given where fuel is. I know fuel is passed through in cargo. It's the same -- it's pass-through and charter as well.

Yes. So that's what I was going to add. I mean we would have been trimming scheduled service capacity probably because of fuel, but about 1/3 of our business, 1/3 of the fuel that the company consumes is in the charter and cargo businesses. We're immune to fuel price [indiscernible] there. So Amazon pays the fuel bill and our -- for the charter contracts we basically pass on the fuel bill to the end user. So we have sort of a nice natural hedge built in around fuel costs because of those 2 segments.

Yes. Yes. Makes sense. So with all these issues going on in the industry, one of your larger competitors on their earnings call started talking about everything we're going through right now is structural. Nobody is going to be able to really fund the growth that everyone is expecting given the pilot and labor issues. What's your view on that? And when do you think we can get the -- from an industry perspective, right? Because completion factor, like it's not great right now. Like when do you think things open up and kind of growth plans can resume?

So there's a few facets to that question. One is, I think, there's been operational challenges because people are flying at very high average line values because they don't have enough pilots. So they're using the ones that they have very hard. What happens is when there's an operational disruption, whether it's weather or maintenance or whatever, in the network, it's a little bit out of whack, your ability to recover is very limited.

And I'm sorry, what do you mean by average line values?

Yes, sorry. So there is an amount of hours that you can schedule a pilot to in any given [ model ], which ranges airlines have very high line values during periods of peak, the summer and much lower line values when there's not as much flying happening. Most folks have been flying very high average line values because of the lack of availability. That winds the system very tight when there's a problem, recovery is very hard. So there's pilots that have to be hired just to sort of catch up and unwind some of that -- the tightness built into the system. And then there's pilots that need to be hired to fund growth. And I think there's sort of -- there's a cyclical problem and there's a structural problem. The structural problem, while not as acute is more longer lasting. And it's just not as many people becoming pilots over the last 5 or 10 years. Military not producing as many -- that's going to have to work itself out.

Yes. How does that like -- is it just all the airlines need to go through new contracts and kind of reset higher? Like what are the recruiting factors for the industry to get -- kind of get those numbers up.

I think it's some stability in the industry, which it's now had for a number of years and it is average pay going up, and it is just awareness that there are a lot of jobs available. I mean I've seen some statistics that people applying to schools to become pilots is way up. So the problem should fix itself, but that's a multiyear fix in order to fix that problem.

I hear there are billboards advertising kind of pilot [indiscernible] in certain cities.

Yes, exactly. And I think enrollment is way up. So I think that problem is there, but it's not the main problem right now. The main problem, in my view, is a cyclical one brought on by COVID and very high levels of buyouts, attrition, all this kind of thing among senior pilots at legacy airlines. When you think about the -- I know this gets a little technical, but it really is what's driving the issue. When you think about a wide-body captain leaving, what's required to replace that person. A narrow-body captain moves into the slot, which means that position open. So the first officer moves and it ripples down the whole chain. So you have a huge build and training and availability. Now you're hiring people, but you suddenly need even more pilots because so many of them are in training. I think that's largely what's driving the world right now. That can take a year to sort of work its way through.

Yes which I mean it's line, it's not, right?

Right. Exactly.

If things can be worked out by next peak season, that could be good.

Exactly.

Maybe moving on to, I guess, Sun Country's costs, right? I think you've had a goal out there of nonfuel CASM sub-$0.06. Obviously, inflation is ramping out there. What are the building blocks to get to that goal?

Yes. So the biggest building block is continue on the growth trajectory that we had planned. And then we have been -- since we all sort of got going here at Sun Country 4 years ago or so, we have been taking costs out of the system sort of throughout -- our average aircraft ownership costs are down probably 25% from what they were a few years ago. We've converted ourselves from an operating lease model to a purely owned model. We did a lot of lease buyouts during COVID and we got very good deals on those aircraft. So that's taken costs down. We have a very active program of reducing our maintenance costs by foregoing overhauls, buying green time engines and really trying to take advantage to a lot of the surplus capacity in used aircraft that are out there and largely a result of sort of COVID and the resumption of MAX deliveries and so forth. We have -- we revamped our website totally. Our distribution costs are down significantly more -- a bigger portion of our bookings are done directly.

Yes, that's what I want to ask you about that. That seems like a pretty big opportunity just given kind of the fee you pay for kind of the non-direct bookings? Just what percentage of your revenues come from -- come direct now versus a few years ago?

Yes. So we have direct -- our direct through the website has been around 60% versus a few years ago, and that was more like 40%. I expect that 60% to moderate back a little bit. And here's sort of the reason. We have seen a huge growth in direct distribution in Minneapolis, which is our major market where people know the brand, they come to the new website. So the new website has really paid huge dividends there. Outside of Minneapolis, where we've been growing, people don't know the brand as well. It's not our model to invest big advertising dollars to build a brand elsewhere. We're in the GDSs. And when we're in and out of a market for very short periods of time, we rely on GDS traffic to basically fill the aircraft. To the extent that we're growing that business a little bit more quickly, maybe a little more slow than we would be -- a little more quickly than we would be in Minneapolis that this average distribution is going to maybe taper down to 55-ish percent direct kind of thing.

Okay. Got it. I'm sorry, you were going through the other building blocks. I don't know if I interrupted you on that.

Those are the major ones. But we've done 1 million little things. We moved our headquarters. We're in a converted hanger on Minneapolis airport. I mean we're very, very cost-focused at the company. We've been able to absorb most of the cost of our new pilot deal. So it's really growth, continued doing the little things as maintenance things are just starting to sort of pay dividends for us. The aircraft ownership trend will continue. So it's all those pieces.

Yes. And then I guess, I'm sure like optimal utilization helps. So is that...

That's a great point. So we had aircraft utilization levels probably and this is lower than the other ULCCs. But in the 9s, I'll give you ballpark numbers in the 9 hours sort of 2019, that number is between 6.5 and 7 right now. And part of that is the design of the model, and we're always going to be lower because we're not using the aircraft when the demand isn't there. There's low cost growth to be had simply through getting our utilization back up as our pilot resource becomes more available.

Can you get it back to -- can it go back to 9? Can it go higher than 9?

I don't know if we want to drive it to 9. It can go somewhere between, let's say, 7 and 9.

Okay. And why wouldn't you want to do that? Because I think 9 would still be below most other carrier.

So think of it this way. During peak periods when demand is strong for leisure traffic, we'll be using the aircraft 12 hours a day. When in September on a Tuesday, we'll be using the aircraft a couple of hours a day. So the nature of the model is such that we're not going to be flying 12 hours a day every day. We'll be flying as hard as we can when the unit revenues are there and is much less when the unit revenues aren't there.

That's fair. That's fair. And I wanted to touch on your -- the ownership costs and kind of the movement away from leasing towards ownership. But I think there's a point to be made for either. You obviously have the balance sheet to do the ownership. But kind of what was the driving force of moving away from lease. Why are you so focused on owning your aircraft?

A lot of it has to do with the fact that Sun Country was paying significant maintenance reserves for aircraft. There's significant return conditions that we had to meet. We are able to fully manage the maintenance program now. We're able to operate the aircraft for as long as we need to or able to optimize the maintenance program for the way that we fly. All that are using in the direction of owning the aircraft. Our balance sheet is very strong. We actually reduced our gross debt levels during the COVID period. We have low leverage. We have a lot of cash on the balance sheet. The used aircraft market continues to be very favorable for us. So from an operating expense perspective, from an ownership perspective, owning the aircraft makes a lot more sense.

On that point on the balance sheet and everything, maybe talk from a liquidity perspective, where -- what is the -- like how have your thoughts on liquidity change over the course of the pandemic? How much do you think you should have on -- what's the optimal liquidity do you have on hand going forward?

We have -- without giving an optimal number, we have considerable excess liquidity right now. Of our revenues, we probably have total liquidity of around 35% to 40%. The business doesn't need anywhere close to that level of liquidity, partially because a significant portion of it, mainly the cargo piece but also a lot of the charter piece is very sticky and fixed and we can count on it. In addition, we keep our -- we try to keep our variable costs as high as possible. Our aircraft, our ownership costs are very low. So let's say there's a recession or as we demonstrated during COVID, we can pull down flying and take operating costs out of the system very quickly.

On that piece on the cargo side, you say it's sticky. How would that perform in a software consumer environment or in a recession? How does the contract with Amazon work?

Yes. We don't take any risk around the aircraft being filled or not filled. We have a multiyear contract that pays us a fixed amount per aircraft we operate and a per block hour amount. So that's the way it's structured.

And that's multiyear.

Yes, exactly.

That is pretty sticky. And then when you do buy new aircraft, how do you think about the -- given excess liquidity, are you going to be paying cash for aircraft? Are you going to lever them up? How do you think about that?

We just did a financing that we completed a couple of months ago, relatively low LTV, EETC would probably continue to look at. What our model has been for the last year or so has essentially been -- we find an aircraft, we pay cash for it, sitting on our balance sheet that when we aggregate enough aircraft together, we will go and do some sort of a financing. The business is cash flow positive today. We may or may not continue to do that. Maybe we do lower LTV stuff. But there's probably some combination of financing and just continuing to own outright. But we don't have -- along this flexibility theme, we don't have any fixed aircraft order book. we never have. So all of our aircraft are sourced in the spot market, the used market. We have a fleet team that looks at dozens of aircraft for every one that we take. We keep prices low and we can be perfectly flexible we can stop and not buy aircraft for a period of time if we want or just get very active in the market.

Got it. Anybody in the room have anything? if not, I guess 1 or 2 more from me with a few minutes left here. But obviously, your Minneapolis concentration. Is there ever a thought of being able to expand and build larger bases outside of that area as kind of a source -- kind of a sourcing market?

Yes. So I think the answer is because we get the question, are you going to build another sort of big mass base like Minneapolis, the answer is probably down the road. But we see at least for the next 3 years, plenty of growth in exactly the model that we have now. And some of that growth is in Minneapolis, which is additional leisure destinations, some additional frequencies and a lot of it is outside Minneapolis. So in the summer months, for instance, we redeploy some of our aircraft to Dallas, and they fly from Dallas to the Caribbean and a few other places or where there's demand, then we're sort of out of there when -- in winter months when they come back to Minneapolis. There are markets all over the place for us. West Coast, Hawaii, this kind of stuff that we're in and out of. There's a lot of that. We have a network plan built out right now to the end of 2025, which doesn't involve any sort of big new bases. So I think that's probably a yes for the airline at some point, but not over the next several years.

What type of markets would fit the bill for -- to be another Minneapolis? Like what are the attributes as you're looking towards?

We have -- what we've concentrated our flying is somewhere where there may be a little bit of brand recognition, where we can get profitable very quickly. And these aren't going to be the size of Minneapolis. But think of midsize, Midwestern cities, the Madison, Wisconsins of the world. Cities like that where we've been adding more frequencies to leisure destinations. It's going to be sort of that sort of more midsize, smaller stuff for a while. In terms of another big base like Minneapolis, this company has existed for 40 years and built the brand over that period of time. So there's no sort of obvious targets out there. But it will be the peaky stuff, very seasonal stuff and then probably more just growing in our core Midwestern markets.

Yes. Makes sense. I guess one thing I didn't touch on is, and we're seeing it a lot of your peers is just -- there's just been really strong growth on the ancillary side, right? Do you have any sort of unique products? Or how do you think about kind of the growth of that area? And does there reach a point where kind of the non-ticket portion, just like, do you max out in terms of percentage of total fare, right, like, I don't know what it is, 60, 70, whatever number it is.

We've had huge ancillary growth. That's been one of the biggest growth of our profitability over the last 4 years. It's growing dramatically. We think we have, if not the highest, very close to the highest ancillary performance in the industry if you measure it on an apples-to-apples basis. We think there's probably more to squeeze out of that but not the leaps and bounds that we've had. But there's still -- we've been saying another $2 to $5 per passenger, just in things like optimizing seat pricing. So for instance, right now, it's a fixed price as to where in the aircraft, you're going to buy the seats. Ideally, we would yield manage that and [indiscernible] based on how many are left. If we're going do that today, we've got to build that engine.

You probably need to build a whole new.

Exactly. To do that and we working on that. There are bundles that we don't do a very good job of right now, sort of bundling ancillary for maybe a lower cost, but the average cost will be higher than what any pass-through would buy. We're working through that. And then there's a whole world of things that we're just sort of getting into, which is third-party products. So we're starting to do some -- we're doing some rental car stuff, but there's more to be done on the hotel side and that kind of thing that could drive a sort of above that $2 to $5 per passenger. But just in terms of internal optimization and proper packaging, we think there's probably another 10% upside in ancillary.

Okay. So on the final minute or two, you've now been public a little over a year. Like as you're at conferences like this, and I know it's a busy conference season now, what do you think -- like from an investor standpoint, what do you view as kind of the biggest misperception that you see out there for Sun Country.

I don't know what the biggest misperception is, but I think what may be just the lack of perception is what we believe to be a truly differentiated model. If you look at us relative to other airlines, we've traded well since our IPO, but we think we have a unique model. We were the most profitable airline in the country during COVID, the most profitable in 2021. We think we have a unique model, which people don't understand fully because it's a little bit complicated, and it's a little bit different. But it's sort of, I think that, that needs to be more widely understood.

Got it. Okay. Any final question? One last chance for the room? Doesn't look like it. Dave, thanks so much. Appreciate it.

Appreciate it.