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

All right. Well, good afternoon. Welcome to the -- I think the last session, at least fireside chat session here at Barclays 41st Annual Industrial Select Conference. I'm Brandon Oglenski, airline and transportation analyst. With us on stage, Dave Davis from Sun Country Airlines. Airline based out in Minneapolis. And you probably don't know it, [indiscernible] around Minneapolis. But we're definitely going to have a good chat here. I think we'll just skip over the [indiscernible] stuff. But so, Dave, thanks for coming down. I appreciate...

Thanks for having me. I appreciate it.

Tell us about -- we've actually been hearing a vibe at this conference about airlines, people, primarily investors, interested in the sector. And I think we've seen from some of your competitors, relatively strong 1Q revenue guidance. I think that goes hand in hand with a pretty strong outlook from you guys for the first quarter. So...

A little bit of context for people who don't know us as well. I mean we operate 54 aircraft right now, a number of the aircrafts on the way in the next 24 months. We were the most profitable carrier on a pretax basis in the U.S. last year. And I think we put out some strong guidance for the first quarter, and we expect to continue, to continue to see the kind of results we've put up. So our ASM growth in the first quarter will probably be sort of mid-double-digit teen kind of numbers, and we put up strong margins as well. So I think for us, leisure markets remain strong, some markets in particular, but sort of steady as she goes. We expect to put up good numbers for the quarter and for the year.

Yes. I mean your operating margin guidance, I think, is 17% to 21%. Is that right?

Yes.

It's very healthy. Now you do have some seasonality in the business. Can you talk to the peak period, because I think first quarter is your strongest?

Yes. So the airline operates through 3 segments. We have a schedule service business, we have a charter business, and we have a cargo business that operates [indiscernible]. All 3 of them, 737 NG aircraft can cross-utilize. Our pilots cross-utilize the aircraft between scheduled service and charter. Our business specializes in flying leisure passengers, basically from northern tier cities, [ discounting ] destinations in southern U.S, Mexico, the Caribbean, where this airline flies. People are traveling in the winter so our first quarter is our strongest. Demand is very strong right now in Q1, but it's seasonally our strongest quarter. June and July for us have been getting a lot stronger as well, particularly July, as we build out the network. But yes, it's Q1 is our bread and butter quarter.

Well, Dave, how much of your scheduled passenger service, you talk about 70% of your revenues are there, right?

Yes.

How much of that is based out of origin Minneapolis?

So the airline, for the scheduled service business, not for the charter or cargo business, but for the scheduled service business is fairly Minneapolis-centric right now. So 55% to 60% of our traffic is Minneapolis originating, then the rest of it, we move aircraft around a lot. The schedule is highly peaked. We schedule a lot in periods when demands are high and a very little in periods when demand is low. So for instance, March we'll fly probably 60% more ASMs than we flew in January. That's on the business [ loops ].

And even day of week, because I think I've been through Minneapolis on a Tuesday, and I see a big number of your fleet parked outside. Is that correct?

Yes. So it's very day of week specific and it's very month of year specific, and it's very geographically variable. So we move the aircraft around the country. We fly different cities, different times of the year. We emphasize charter flying more in certain off-peak periods, less in high peak periods. So the beauty of the model and the whole point of it is not to necessarily drive CASM as low as possible through high utilization. It's to fly when demand is strongest and capture high unit revenues. We're tight on cost control as well, but it's not a utilization-focused model. It is a high unit revenue-focused model, and that's what's sort of driven the success of the business.

And just on revenue, how much are you planning to go in the first quarter? And what should we be thinking about for the full year?

So our plans right now are to grow sort of high single digit to low double digit, let's just say, 8% to 10% a year from a block hour perspective in 2024 over 2023. Most of that growth will be allocated to our scheduled service business. So we'll probably see ASM growth in the first quarter around the order of, let's just say, 12% to 14%.

And I think that's a more elevated growth rate than we've seen in the past couple of years. Remind me, I think you had some challenges with first pilot training issues and then pilot upgrade issues. Has that been resolved?

So the challenge, one of our biggest challenges over the last, let's say, 12 to 18 months has been staffing, particularly on the pilot side. And it hasn't been pilot hiring, which we've sort of been able to bring in as many pilots as we need. Attrition has been relatively low. It's really been getting people to upgrade into the captain's seat. And there's a long variety of reasons for that complexity, which I could go into, but I think we're largely through that problem. There's more progress that we need to make, but we are largely able to grow pretty close to where we want to grow at this point.

And how far back on schedule with that pilot issue to where you want to be in the network today?

That's a good question. We're -- if I look at sort of our original IPO plan, we're probably a year or so behind from a growth perspective.

And remind me, how many aircraft do you have in the passenger service?

Here is our fleet today. As of year-end 2023, we operate 54 aircraft; 12 of them are freighters, the other 42 are passenger aircraft. We also control another 7 aircraft that we have on lease to 2 carriers. Expecting delivery of 2 incremental aircraft in '24. And then in '24 and '25, those 7 aircraft will come off lease and go into our fleet. By mid- to late 2025, our fleet should be at around 63 aircraft.

So how many more incremental will that be, sorry? Or is that just taking...

It's 2 more new aircraft to the fleet and then the 7 incremental that are currently on lease coming back into our fleet.

And can you remind us how that's impacting the P&L? Because I think you have a lease revenue line right now, is that correct?

We have a lease revenue line. From a P&L perspective, we expect the aircraft to be at least as accretive to the P&L when we're operating them as they are when they're [ leased ].

I think for the investor audience, you really care a lot about aircraft, and Boeing is obviously a hot topic. But you are maybe in the next generation type of the prior gen 737 family.

Yes. So the fleet philosophy of the aircraft -- sorry, of the airline is mid-life 737 NGs. That's what we specialize in acquiring, and that's the totality of our fleet. We don't have a dedicated order book. We haven't bought any new aircraft, it's all mid-life 737 that we bought in the open market. I think a really important thing about our company, as we move into '24 and '25, is sort of where we sit from a fleet perspective. The company does about $1 billion in revenue, a little bit more than that on an annual basis. In 2023, our CapEx is about $225 million. We bought a number of airplanes. Those airplanes are now on lease and they'll come back to us over the next 18 months, as I said. But our CapEx budget is going to drop from, say, $225 million, probably sub-$100 million in 2024 and 2025. The business is a strong cash flow generating business. Our operating cash flow is strong. So that drop in CapEx basically will drop to the bottom line. We've been actively buying back shares now since the end of 2022. We'll make cash deployment decisions as we move through '24, but the business will generate a lot of free cash flow.

I feel like you guys don't get a lot of respect with the valuation, but these are pretty good numbers. And in fact, I think last year, you guys did have close to, if not the highest operating margin in the industry, is that right?

From a pretax perspective, we had the highest margin in the industry. I have to go back and look at operating, but we were #1 or close. From a pretax perspective, it was we were at top of the industry. So we put this new model in place and we really started this in 2018 when we were a private company. In 2023, we were the most profitable airline in the country. In 2021 we were the most profitable airline in the company. In 2020, we lost the least of any airline in the company -- country during COVID. So I think our track record sort of speaks for itself so far.

Yes. And in terms of Minneapolis in the network and growth, how many new markets do you see on the horizon through 2025?

So we just sort of in our summer and mid-fall schedule, so we'll have close to 100 destinations from Minneapolis right now that we fly. There's still substantial growth that we can -- in Minneapolis as well. But here's the -- again, this is sort of the secret sauce of the airline. We're not -- these aren't like multiple destination -- multiple times daily all year round, very highly specific day of week markets, specific months of the year. So it's a lot of destinations, but very few of them are flown on a year-round basis. That's the specialty of the airline.

Right. And the way you distribute is different from other low-cost carriers as well, right?

We are -- we -- so it's -- again, it's very bifurcated. In like our home market of Minneapolis on the scheduled service side, around 70% of our tickets, a little more than that, are sold direct through our website. Then in other markets, since we're in and out of these markets so quickly, we really don't spend much on building brands in these cities. So we're in all the GDSs. So basically, we compete around the country based on sort of during peak -- during periods of peak demand, we sell through GDSs and in Minneapolis, it's mostly direct.

And, how much has ancillary is actually become a bigger source of revenue?

Yes. Yes, I mean ancillary is growing significantly for us. Our ancillary production now is roughly on par with the other ULCCs. There's probably more upside in that, probably $3 to $5 per passenger, just through some -- largely through some automation and different sort of methods of merchandising that we have underway.

And we do get a question from shareholders or potential shareholders, what about Delta? Because obviously, along with [indiscernible] hubs, compete directly with them on a lot of these routes. But can you speak to the unique aspect of your network?

So first of all, the airline is 100% based, as close as you can get, 100% leisure traffic. So we're not involved in business markets, schedule is not set up for that. So that we're really not competitors there. It's also point-to-point. For the most part we have some connect, but it's point-to-point so the Delta flows a lot over Minneapolis. The other thing, as I said, is we are focused on periods of peak leisure demand and not in other periods. So just to give you a statistic, 2019 to 2023, our passenger share of Minneapolis grew from about 11.5% to almost 20% over that period. Delta actually grew a little over that period as well. What happened is everybody else dropped by almost 10 points. So really, we've been able to sort of consolidate this market to some extent between the 2 of us. We operate in a different terminal than Delta. Like, as I said, we have a much different schedule [indiscernible].

Well, and for those that maybe aren't in Minneapolis, it's hard to envision, but the terminal access is actually one thing that your customers probably appreciate. Is that right?

Yes. So the airport there is not a -- there's a main terminal, a very large terminal set up for connecting traffic, set up back for Northwest Airlines and then through their Delta acquisition. Then there's a separate terminal which is not even connected by a simple people mover. It is really set up for low-cost carriers. We're the dominant carrier in the terminal by far. Much smaller. Parking is right there, very quickly through security. So it's super convenient for passengers. We hear good things about it all the time.

Because we just had [ Glenn Harocine ] up here a little bit earlier, premium demand and segmentation of its customers, but that's something that you guys are focused on as well, right?

So like I said, our business is the leisure business. The model is focused on diversification of revenue streams and cost utilization of assets. So we have the scheduled service business. We also have a significant charter business. 90% of that charter business is long-term contracts, be it with Major League Soccer, with various casino companies. That is a solid, very profitable business, and then we operate 12 freighter aircraft for Amazon. Pilots are cross-utilized across all the assets. Aircraft cross-utilized with mixed scheduled service and charter. So what allows us to operate this very peaked scheduled service business is that we have other businesses that are either countercyclic like the charter business or very steady like the cargo business. So we get the advantages of peak scheduling from a revenue perspective and the cost advantages of higher utilization because we have these other segments.

[ Raj, ] do you have a question?

Yes, I have a question around [indiscernible] your pilots. You mentioned it in the last call as well. You said it was kind of drag to EPS over the past year. How is that progressing this year? And as you said, attrition is very low, but as you come up on a new pilot contract, will higher wage rate basically resupplement [indiscernible] year?

Yes. So I wouldn't sort of look at it this way. In 2023, we were short pilots, mostly on the captain side. What that forced us to do is, to fly the schedule, we offered a lot of premium pay. So time and a half, double time to get pilots to pick up trips. That works fine, but it's expensive. We have largely come through that problem. So our premium pay numbers are down significantly in 2024, and we're able to grow the airline at the level that we want to grow it. Done a lot of hard work, but I think we're largely through that. You could always see more, but it's not the headwind it was. From a new pilot contract perspective, we're a little bit in a different place than some of the other airlines. We signed a new deal in December of 2021. So we're not -- there's no upcoming cost increases here in the very near term, a 4-year deal, so it would be up at the end of 2025, and then however long it takes to negotiate a new deal. So there's something down the horizon, but for the next few years, we're just going to operate and draw up a new contract.

Follow-up on [indiscernible] on high-demand routes. But then on the cost side as well, are there other efficiencies you can kind of take out of your operating model to expand your margins?

Yes. So I think on the cost front, like I said, our CASM, just by the very nature of our business, is going to be higher than it is for some of the other ULCCs because we don't -- we're not seeking that [indiscernible] utilization of the aircraft. As a result, we're really cost-conscious elsewhere, and our fleet strategy is one of the major ways that we've done that. We don't have brand new aircraft that we've got to keep flying in order to justify the ownership costs. As I said, it's an older fleet, midlife 737s, that's a key part of the strategy. And as we sort of work through the business, there's more opportunity for us to take additional cost out. There's a lot of automation that still needs to be put in at the company. For instance, we don't have a pilot preferential bid system, which almost all other airlines have. We're in the process of putting that into place. That will drive efficiencies. There's more efficiency to be driven on the maintenance side of our company. We outsource all of our heavy work. There's a lot more we can do on that front. I mean I think we'll see that start to bear fruit really in the '25, '26 time frame. That should be a -- should be cost -- a unit cost tailwind for us.

And the aircraft they have on the lease with other airlines, that are going to come into the fleet, that's the 900 variant, is it not?

So we have 7 aircraft on lease, 2 of them are 800s and 5 of them are 900 ERs. That will allow us basically to provide us some upgauging opportunities in peak markets at peak times of the year. So let's say, Minneapolis to Fort Myers, those kind of markets which are almost insatiable in the March time frame, we can upgauge and get more seats in the market.

Is that like 15, 20 more seats you can fit in there?

That's what exactly what it is. Yes.

You get a CASM benefit as well?

There will be a CASM benefit as well, exactly. The overall operating cost per shell are almost the same, but there's a CASM benefit.

Okay. How scalable is the charter market though, going forward? [indiscernible] 50%, 100% bigger a few years down the road. Can it scale...

Yes, so ideally, we would continue to grow, and I can't say this is going to happen every year because it doesn't -- it sort of doesn't work that straight. But basically, we want to grow all the 3 segments kind of roughly proportionately as we go forward, in some years, more with one segment and some years less. There's more opportunity on the charter side. There are more long-term contracts for us to win. There's more premium flying we can do which we don't do today, like VIP [ pip ] line. And there's also a market that we have largely gotten out of just with our pilot situation in the past, which is ad hoc charter flying. That is charter flying that is not under long-term contract, but you bid out like a month out. That used to be 50% of our charter business; it's now about 15% of our charter business. That business is still out there. As we continue to build up our pilot resource, we'll get back into more ad hoc charter flying. So there's plenty of growth opportunity there as well.

Probably good to highlight, too, your charter flying [indiscernible] the fuel risk.

Yes. So basically, we don't do any fuel hedging anymore, that roughly 30% of our fuel consumption is sort of perfectly hedged. With both on the cargo business and then the charter business, we don't look fuel risk. On the cargo business, it's [ literally ] paid for by our customer. On the charter business, if fuel goes up, there's an offset true-up that's done [indiscernible].

Got it. And on the Amazon contracts, I think when it would start, pretty healthy profitability we could see on the P&L, but you did get the reset in pilot rates with the new contract. Then from an operating perspective, closer to breakeven, the way we could see it on the P&L. Now I know there's allocation of fixed cost going on there. But can you talk to why we [ time ] the outlook with Amazon?

So the business is a solid cash flow generator from us -- for us. On the P&L, we report 2 segments, passenger, cargo. There's some fixed overhead and stuff allocated in cargo business. But all that said, profitability of our cargo business has deteriorated since we first got into the business in 2020. I believe there will probably be an opportunity for us to grow that business in the quarters ahead, quarter and years ahead, but we need to do something on the economic front. We get it performing like the rest of the businesses. So I would take that as sort of a key initiative for our company as we move forward into '24, '25.

Okay. So coming back to scheduled passenger because I think that's where you and Jude would say, we would most like to allocate our resources today, if we could. And again, coming back to growth this year. What about markets outside of Minneapolis?

So, I think for the foreseeable future, you will see us continue with this, we call it, sort of a scraping strategy. There's really sort of two ways to grow. One is to establish a brand recognition in a given market, invest in advertising, put some aircraft there year round and really sort of grow it. The other is what we call sort of scraping, which is moving the aircraft around to capture peak demand, capture peak pricing at periods of peak demand.I think the next few years for us are going to continue to be that scraping strategy because there's a lot of opportunity out there. So I think that's sort of where the growth will be. Now that said, some of the markets that work particularly well for us, as maybe you would expect, are sort of upper Midwestern markets. So the Madisons and the Milwaukees, cities like that. They're not as big as Minneapolis, but there's some brand recognition and they work very well. So I think you'll continue to see growth in those markets. And then we also have a small operation, smaller in [indiscernible] that we operate in Dallas, which is [ we loosen that ] there in the summer. Like basically if people in Texas do Caribbean and beach destinations, I think there's probably more opportunity there as well. So for the next few years, you're going to continue to pursue this moving the aircraft around strategy. Maybe at some point, we try to establish more dominance in a given city, but that's a few years down the road.

[indiscernible] used aircraft value, especially given production challenges on Boeing and on Airbus, how has it impacted the NG market? I know you have capacity planes to '25, but beyond that?

I can't say where it's going to go beyond '25, but it's -- yes, I mean the used aircraft value has gone up, let's say, in the last year to 18 months. We're fortunate to have locked these aircraft in at the prices we want to pay. When we stay active in the market, we scour literally hundreds of deals to find a few aircraft that we need to grow. So we'll continue to be aggressive, but used aircraft pricing has firmed. And I think that will probably remain the case until we see production rates increase, if only [ basically ].

Got it. Go ahead, [ Jim ].

[indiscernible] that you see over the next [indiscernible] but you're also growing like low double digits annually. Where is Sun Country in like 5, 7 years? Do you see yourself opening a new crew base or kind of replicating what you did in Minneapolis, in Dallas or Milwaukee? Do you have like a longer-term margin target that...

Yes. If you're looking sort of 5 to 7 years down the road, there probably is another focus city for us on the horizon. As we said, look where we end, we end '25 with -- 2025 with let's say 63 aircraft operating. That number could probably increase by 10% a year for the foreseeable future. There'll be fits and starts. There's probably, as I said, will be more client to do on the cargo front, definitely more charter flying to do. From a target margin perspective, our adjusted pretax in '23 was around 10%. I don't think there's a reason we can't drive that more consistently to be low to mid-teens pretax margins.

And then can you touch on the capital side of the balance sheet? You have financed with the aircraft, right?

Yes. So the balance sheet of the company is pretty strong. We finished 2023 with a leverage ratio of 2.2x. That should fall to sub-2 here as we move through 2024 relatively rapidly. But again, all the aircraft that we need, we've already sort of purchased. We already have the financing lined up for it. We only have 3 pieces of debt, with 2 EETCs and a term loan on our balance sheet right now. So we just don't really have financing needs or new aircraft needs over the next couple of years. So like I said, roughly, we'll spend $100 million or so on CapEx. That is sort of systems development, some maintenance CapEx. And then we have a very active greentime engine strategy, where we haven't been doing overhauls of engines, but we've been in the market actively buying the greentime on them. We put those on the wing. When the engine is run out, we tear it down. We have a consignment agreement, we keep the parts we want, sell the parts we don't want. We've been -- that's been underway for 3 years or so now, and it's working really well. That's what our CapEx is over the next couple of years. It's engines and automation.

And as we're winding down here, I guess as you look out over the [indiscernible] and again, we heard this from a few of the other carriers, but environment is still holding pretty positive. In fact, I think probably you would say maybe a little bit better than expected but what you guys [indiscernible] booking trends.

I think that the environment remains sort of overall constructive. First quarter of last year was really, really strong. I think first quarter of this year looks good. So overall, we see a great environment. I mean I don't see any massive acceleration, but not deceleration either. It's very steady, steady growth for Sun Country.

Dave, really appreciate you being here and really appreciate everyone coming to the Barclays conference. So thank you all.

Thank you, Brandon. I appreciate it.