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

Great. Welcome, everyone, to Day 2 of the Laguna Conference. Welcome to Day 2 of the Laguna Conference. I'm very happy to have with us Sun Country Airlines and CFO, Dave Davis. Dave, thanks so much for joining us in person.

Thanks for having me.

Yes. So before we kick off, I have to point out that for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. I hope they can clean out the reverb at some point. Dave, Sun Country has one of the most unique stories in business models in the space. So for those who -- and also you're a relatively new IPO. So for those who are near to the story, do you want to just share a quick intro of who you are and what makes you so unique?

Yes. So Sun Country is an airline based in Minneapolis. Our schedule is -- really consists of -- our airline really consists of 3 segments. So we are unique in that we operate across a scheduled service segment, which is our largest people buy and sell tickets as you normally expect. We have a significant charter operation where we fly for groups like the MLS, various casinos and others. And then we also have a significant cargo operation. We fly 737s for Amazon. The business is unique in several different facets. It's a highly resilient business because we operate across all these 3 segments using largely the same resources. So it's all 737-800s across all segments. We use the same pilots across all 3 segments, same flight attendants across charter and scheduled service, same maintenance organization services all the aircraft. So the airline has performed really well over the last several years. We led the industry in margin in 2020 and 2021 through the first quarter of '22, which is our strongest quarter of the year. A little bit about the history of the company. It's been around for 40 years. It's actually our 40th anniversary. The company went through a significant ownership change and really a change in business model to where it is today in early 2018 when we were acquired by Apollo Global Management. Since then, our new management team has come in and really transformed the company to what it is now. We went public in March of '21, and we've been trading ever since then.

Got it. That's a good intro. So maybe just to get into it, obviously, the #1 topic in most investors' minds right now is how things are trending, especially coming off of a very strong early summer. So what has the late summer been like for you guys and kind of what's it looking like in the fall, knowing that you have more seasonal operations than most of the airlines?

We continue to see strength throughout the booking window. Our schedule goes out through next spring at this point. We are seeing strength. First of all, we're 100% leisure. We don't -- our network is very peaky. It's very leisure-dominated. We don't cater to business traffic at all and we're continuing to see leisure bookings very strong, not only high load factors, but extremely high revenue as well. So if you look into sort of 2023 right now we're seeing dramatic increases in unit revenue as well as load factor over what we've sort of seen in a typical year. So sort of no pullback so far. Third quarter for us, we gave some guidance. It's shaping up to be very strong. So we're highly confident that we'll perform there. But everything looks green right now. The only issue for us is just one of capacity. So we are working through some capacity issues that are limiting our growth a little bit, but revenues are so strong, it's making up for a lot of that.

Got it. You're the first airline to even venture kind of giving us a glimpse into 2023. So thank you for that. But if you can kind of unpack that a little bit more, kind of what is the trajectory looking like into the holiday season and into '23, kind of if you can share kind of some relative to 2019 or versus expectations sequentially in...

Yes. So just maybe some examples. So like I said, things are very strong through the holiday period into 2023. If you sort of take a snapshot, let's say today and look forward into the first quarter of 2023, and then compare the bookings -- that booking profile to a similar time in 2019, let's say, looking into 2020, so COVID wasn't known, a typical year, we're seeing load factors up significantly. And so far, unit revenue is up 50% plus.

Oh, wow.

Yes, over 2019. Now that will come in a little bit. It will come in a lot probably as we grow, but it's just it's incredibly strong. So high fares, high loads and it's persistent as far out as we can see.

Got it. That's a pretty remarkable statistic, kind of most people who think often ahead, ultra-low-cost carrier, you have a very sensitive -- price-sensitive customer. How are they able to absorb a yield increase of this kind, kind of obviously, it's the whole value proposition, not just fair but kind of do you feel like at some point, you're running out of room there or do you think there's more on there?

Maybe we run out of room at some point. But so far, people seem to be wanting to continue to go on vacations and spend money on travel. So we've seen no weakness so far. I wish we had more capacity available to fly right now, but we've seen no weakness. I'm sure it's sort of at some point, it gets to a place where people aren't going to travel as much, but we're not seeing any of that so far.

Got it. Let's talk about the capacity point because, obviously, most -- a lot of investors in this space would say, hey, this is a golden time for the period right now where you're getting really strong yield and capacity could potentially put that at risk. But at the same time, capacity is also an opportunity for real growth. So can you just talk about your capacity plans and what can you do? What would you have done if you didn't have a resource constraint and kind of where that goes over time?

Yes. So one of the things about our story is, as I said before, we're somewhat unique. And it's -- we have this large cargo segment. So we look at our capacity mostly in terms of block hours and less so in terms of ASMs because obviously, the cargo business doesn't generate any ASM. So if you look at our growth, let's say, the size of our airline in 2022 relative to where it was in 2019, we're still up significantly. So we're 20% plus larger in the third quarter than we were in the third quarter of '19. We'll be up mid-30s percent larger from a block hour basis in 2022 in the fourth quarter than we were in the same quarter of 2019. A lot of that growth is the growth of our cargo business. From an ASM perspective, we're sort of flattish to down relative to 2019. In the third quarter -- sorry, in the second quarter just finished, we were probably 10% to 15% smaller than I would have liked us to be. I think sort of the yields are basically flat at this point. We could have been 10% to 15% larger without any yield degradation. One of the things that I think I should -- I want to point out about the model that makes it unique and powerful is the way we sort of schedule our passenger business. So it is very seamless between our scheduled service business and our charter business. We have these things that we've sort of termed internally as power patterns. And what those are is where we are scheduling aircraft and crews, a charter segment and a scheduled service segment sort of intertwined. So as an example, well, let's say, fly an aircraft for a scheduled service segment from Minneapolis to Las Vegas, let's say on a Thursday. The aircraft will then do some charter flying up and down the West Coast or in the Western U.S. on Sunday, a scheduled service segment back to Minneapolis. What it allows us to do is it allows us to basically eliminate sort of return legs or other segments that aren't as good as they otherwise wouldn't be in substitute a high-margin charter flight in there. So sometimes our ASM capacity looks -- our scheduled service ASM capacity looks lower than, let's say, the growth of others because we're substituting charter segments. But what that's doing in September, for instance, is driving really high unit revenues because we're able to sort of schedule this way and it's unique to our business.

Got it. That makes a lot of sense. You've said before that you don't really have a pilot availability problem, but you have a pilot training and kind of bringing them on a onstream issue, which is slowly being resolved. So what's the path and what's the visibility to getting that resolved?

Yes. So a little bit complicated story, but pilots are always a little bit complicated. So there's a lot of talk of sort of a pilot shortage out there. We were having difficulty attracting pilots and we were seeing a bump-up in attrition towards the third, fourth quarter of 2021. We worked with ALPA, really worked well together to sign a brand new deal at the end of 2021. So we have a new pilot contract in place sort of ahead of where others are coming. So there's been some cost increases associated with that. But what it's really done is it's essentially fixed our new hire problem. So we have all the new hires we need at this point to sort of fill our pilot classes. The issue for us is just getting them through training and getting them out on the line being productive. And there's a couple of things that are driving that. First of all, our growth, I mentioned our block hour growth, all that's pilots. So we're growing very rapidly from that perspective. So we need a lot of pilots. There's been sort of an industry-wide shortage of instructors that has impacted us. We've taken the number of -- we had about a threefold increase in the number of line check airman, the people at the very end of the training cycle who actually certify the pilot before they fly around together. We've had a threefold increase from June to July. We want to do another doubling of that. So we're still working through this line check airmen issue, but I think we're making good progress on it. We need to continue to get people to upgrade to captain positions and really sort of grow throughout the sort of pilot supply chain. The good news for us is, we're not having a trouble -- we're not having trouble attracting pilots. Our attrition has moderated. So the so-called pilot shortage we don't think is impacting us any longer. We just got to get them through our pipeline and get them on the line.

Got it. So that 10% to 15% gap in capacity that you couldn't fly, would like to fly, is that going to be resolved once you get these pilots through the pipeline and kind of what's the time line that happens?

Yes. So we're working our way through this. We're still smaller than we would ideally be in the third quarter and even in the fourth quarter. I think you're going to see some significant growth from us from a block hour perspective in Q4, but we could be still larger. The big quarter for our company is Q1. That's our strongest quarter when you've got people from the upper Midwest flying to Sun destinations. We'll be largely through the problem then, but we're probably not going to be fully resolved from a pilot throughput perspective until sort of mid next year. It just takes time to get instructors in, pilots to bid, then to go through a 2- or 3-month training process, that whole pipeline takes time to build and develop. But we think we want -- we have sort of the right clip in mind for captain and flight -- sorry, first officer production, which we want to get to by the middle of next year and I think we're well on track for that.

Remind me again, what's driving the 4Q bump in block hours?

We're sort of been working through this pilot issue. So you kind of sort of buildup -- we've been doing a lot of hiring. And so we're sort of building momentum behind that and that will continue through the first part of the year.

Got it. Let's talk about the other 2 segments. So I start with Charter first. Obviously, very unique, very attractive product, long-term contracts with many of our customers. So how much visibility do you have into that? Again, your -- what you told us on the scheduled service side through early January sounds pretty incredible. How much visibility do you have the growth coming on the charter side, which I think you have sort of left some on the table as well because of the scheduled service capacity issues?

Yes. So let me describe how our charter operation kind of works. There's really sort of think of it as 2 pieces of it. There's a part that's under contract. Examples there would be, like I said, we fly for MLS league. We take some casino. We have some casino track flying back and forth between various destinations. That stuff is under a longer-term contract. Then we have an ad hoc business. We like both segments. What the scheduled piece does or let's call it the track business, the contract business does, is it allows us to have a lot of visibility into how much flying there's going to be. We can bake that flying into our pilot bid into our planning early on. So it's efficient for us. The ad hoc stuff is good because it comes in sort of last minute within a few weeks sometimes like before bidding on military kind of stuff. The good thing there is it can be very high margin because we're sort of taking -- bidding on the stuff we really works well for us. Historically, like, let's say, 2019, our business was about 45% under contract and about 55% ad hoc. In the second quarter that we just finished, our business was 95% under contract and 5% ad hoc. We wanted to improve from where we were in 2019, but not go quite as far as we are. So the issue is one of, again, sort of available capacity. So the ad hoc stuff, we will bid on when we have essentially surplus resource, mainly pilots. Given the fact that we've been constrained there, we haven't been bidding on as much of that as we would like. We anticipate part of our growth into '23 is going to be the return of that ad hoc business. It's a little less efficient flying because we don't know about it early on. So some pilot positioning and things like this, but it can be very, very high margin. So the '23 plan is sort of in work. But I think we're right now sort of focusing in on some fairly significant charter growth next year.

Got it. How competitive or not is that business? I think in the past, you've -- there have been periods where it feels like the words are always trying to configure contract. And other times it feels like it's little more under pressure.

Yes. It can be competitive, although it's less so than it used to be. During COVID, you actually had some players exit that business. So that sort of brought the number of players down a bit. What tends to happen is there are other carriers out there who when they have surplus capacity will bid on the charter market. That's going, that's dwindling. As business traffic is coming back and leisure traffic is so strong, people don't have spare aircraft and pilots and so forth. So it's generally less competitive than it used to be. So that's good for the business. So we anticipate it persisting. Again, one of the things I can't stress enough how unique the model is. One, what charter customers want is they obviously want a competitive price, but they want reliability. If you're flying an NHL team from X to Y, they kind of got to make the game, you know what I mean. So reliability is important. We operate relatively newer aircraft. We operate very reliably relative to other charter operators who are pure charter, who focus very much on lower cost as possible. They have older aircraft, maybe much higher pilot turnover, so therefore, less reliable. We can still be cost-competitive in that world, again, because we're cross-utilizing assets across all of our segments. So we can be cost-competitive at much higher levels of reliability. So there is a ton of this business out there for us to continue to pursue.

Got it. Switching to the cargo segment, obviously, one large customer there is Amazon. I think it's 8 years left on that contract, if I'm right. So there's plenty of runway there. Obviously, Amazon has been the headlines the last few months of talking about excess capacity in the system and maybe some slowing of e-commerce volumes. You've been running 100% utilization on that for the last 2 years. But what is the outlook for that looking like the next few months?

Yes. So Amazon's business is obviously a mix of mostly wide-body flying and then some narrow-body flying in the U.S. There's really 2 carriers who do 737-800 narrow-body stuff for them. We're the larger of the 2. In terms of package volume, I can't -- I don't have insight into what's going on there. The way our contract works is we're basically compensated on a fixed fee plus a per block hour number. We've seen sort of no diminishment in the size of the network, the level of flying other than if aircraft are in heavy check or something like that. So I don't have insight again into what's happening into their network, but we've seen essentially sort of no softness in their scheduling at all at this point. It's full speed.

Got it. And any longer-term plans for growth there? I mean, I think at one point, they would have taken as many planes as you could have given them.

Yes.

Is that still the case? And do you still have interest in growing that business?

Yes. So a little bit of the history here. So I guess, fortuitously, we signed our agreement with Amazon in December of 2019. So then COVID obviously happened 12 weeks later. We started ramping Amazon in -- we originally signed a deal for 10 aircraft that quickly became 12. We ramped between May and December of '20. We've been at sort of 12 aircraft operating steadily since early 2021. I think we -- again, I don't have insights into their forward-looking plans, I wouldn't comment for them. But I think we have some confidence that there's going to be more growth there. As I mentioned a few minutes ago, we have certain constraints. There's so much opportunity on the scheduled service side right now that that's what our focus is. So we would -- Amazon is a great customer. We'd love to do more work for them. We're a bit capacity-constrained right now. So we'd love to grow maybe a little bit later, not right away.

Sure. So given the unique net role, like some people may ask why bother with scheduled service because the margin in cargo and charter are higher? Now again, I think that only works if you can slot it into a scheduled service operation, but how do you think of the balance when you see them?

So our scheduled service operation is, let's say, between -- varies through the year. But 60% and 70% of our network is scheduled service. And I'm going from a block hour basis here, cargoes maybe 10%, 12% and the rest is Charter. The scheduled service business, particularly now is highly profitable and is key for us. That's kind of the backbone of the network. And I think, as you said, the other segments wouldn't work as well if we didn't have a scheduled service business. It's the cross-utilization of assets. That's the magic sauce here for the company. I think it's what drives our sort of resiliency. In economic downturns, the cargo business has been very solid. The charter business people still play sports. There's still -- casino traffic is really strong even during recessions, believe it or not. So it all works really well together. Our scheduled service network, there's probably only 1, 2 other carriers who schedule the way we do, which is very highly peaked. So we have high peaks where we're flying all of our aircraft, 12, 13 block hours a day during periods and in geographies where there's a lot of leisure demand. So we're big in Minneapolis in the upper Midwest in the winter when people are going to Caribbean, Mexico, Florida, Phoenix, so forth. And we're smaller there in the shoulder period. In the summer, we actually grow a network that we have in Dallas, where we do a lot of Texans to Caribbean, Mexico and so forth. We've historically done some flying L.A. Honolulu in the summer, 3 months when peak demand is there, then we're out at other periods. What sort of this variable utilization does in our scheduled service business is it's going to drive a CASM a little bit higher than the other ULCCs. We have a low cost structure, but it's going to be a little higher because we don't have the flat schedule, the high utilization, but it also drives much higher unit revenues. So it's maximizing that delta obviously that everybody is trying to do. And we've been sort of either leading or to in the industry in terms of those margins for a long time now.

Yes. That was my next question, which is you're clearly #1 or #2 in terms of margins, normalized margins.

Yes.

What do you think the trajectory is to get back to that? Obviously, the entire industry is grappling with this extremely strong top line driven by yield, but also extremely high CASM-ex because you're not able to fly a full schedule. Obviously, jet fuel is what it is. But when do you think we get back to kind of something close to those margins, normalize those?

The cost increases that have been sort of out there, I think, are largely now incorporated in our business. So a big one is obviously pilot costs. As I said, that deal is done. It's in our 2022 numbers. So there shouldn't be much cost increase, there should be cost reductions in that world, CASM reductions going forward. So a lot of the costs that other airlines haven't yet experienced, i.e., new pilot deals sort of inherent in our numbers. The biggest issue for us, as I said, is one of growth. We think we can be back to -- we're not done yet with the '23 plan yet, but well in the double-digit, into double-digit pretax margins by sometime next year, hopefully, for the full year. But we think '23 right now is shaping up to be a really strong year for us, even at relatively high fuel prices.

Got it. Any questions from the audience? We have one there.

Yes. I just have a couple of questions. [Audio Gap]

our sweet spot for aircraft. Where we get them is all over the place. So we've taken -- we recently took some ex-Norwegian aircraft that came out of the Norwegian bankruptcy. Those are going to be going into our fleet here over the next several months. Aircraft that are owned by lessors coming off lease with someone else, we get them at those sources. The Norwegian aircraft are parked -- a lot of them aren't parked, they come -- they end lease somewhere else and sort of come to us. We have seen -- I always get this question, but we have seen no diminishment in the number of aircraft available for us really since COVID. And the pricing hasn't changed much either. So the market remains a very favorable one from a used aircraft perspective. We don't do any operating leasing. We've been working our way out of operating leases for the last 3 or 4 years. We own the aircraft. We manage the maintenance programs. We operate them until end of life. So we have an active -- we're shopping the market everywhere and looking for aircraft. To your Amazon question, one of the beauties of the business is it's very capital-light. Amazon owns those aircraft. We sublet them from Amazon. They are cargo-configured. So they fly for Amazon. They're their aircraft. We have like a CMI deal, crew maintenance, insurance kind of stuff. So we can't flip them and you couldn't really flip between cargo and passenger service given the configuration of the aircraft.

[indiscernible]

I didn't hear.

The regulatory environment around some of the headlines around IROPs and...

Yes. I mean the key there is sort of getting back to very reliable operations. We had some hiccups actually in the first quarter, particularly like February. But right now we've been operating probably the highest or second highest completion factor in the industry, very high reliability operations. So we haven't been sort of impacted by regulation and haven't been that involved in discussions. We're just focused on running a reliable airline. We have 100% passenger -- 100% leisure passenger traffic. On-time performance is important. But for us, the most important thing is completion factor because we need to get customers to where they need to be. If they're an hour late, they're an hour late, but they're there. So we're heavily focused on completion factor, and we're running, as I said, probably 1 or 2 in the industry. We have been pretty consistently.

Got it. Dave, one of the most interesting stories in the airline space. Thank you for spending time with us.

Thanks. Good to be here.