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

Hi everyone. I think we're ready to get started here. I'm not Jamie Baker. I'm James Kirby. I work with Jamie, covering U.S. Airlines. Delighted to welcome Sun Country Airlines. This side, you have Dave Davis, CFO here.

Thanks, everybody. It's good to see you. And Jamie and Mark, thanks for having us here at this event. So I've got a few slides together here that sort of describe our airline. We've been public now for about 3 years, but a lot of folks don't know that much about us yet. So I'll provide a little bit of background and then talk about our performance and sort of what our strategy is going forward and what our outlook is. I think we can get through that. So this is an overview of our business. Sun Country is like a truly unique airline. And I know a lot of people say that they're unique, but we really are unique. In that we operate through 3 different business segments. We have a scheduled service business, we have a charter business and we have a cargo business. You can see on the slide sort of the relative size of each. Our scheduled service business is about 70% of our revenue, charter is about 20% and cargo is about 10%. The uniqueness of our model is -- this adds a little bit of complexity, but it's all 737NG aircraft. All of our pilots are cross utilized across all 3 segments. They're scheduled simultaneously or sequentially, so they can go from a charter flight, to a cargo flight, to a scheduled service flight. It keeps our costs lower. We have a unique method of scheduling ourselves on the scheduled service side, which I'll talk about in a second. All of our passenger aircraft have the exact same internal configuration, so they move seamlessly between the charter business and the scheduled service business. Just a little perspective on the size of the fleet. So we have 44 passenger aircraft that will be in operation, the last ones coming in by the end of March. We have 12 freighters, 737NGs that we operate exclusively for Amazon. Then we own 7 aircraft that are actually on lease to a couple of other airlines that are coming into Sun Country service mostly in 2025. This is our history. So the history of the company is this airline has been around since the early 1980s, so 40-plus years. It was purchased by a private equity firm in 2018. A whole new management team came in, and we basically put this new business plan in place. And this has been sort of the result at least on the revenue side. So since 2018, when we got started, we've roughly doubled the size of the company from a revenue perspective. So about 13% annual growth over that period of time. We obviously had a dip during COVID, but have recovered very nicely since then, and we expect to stay on this growth trajectory going forward. So revenue growth is great, but it's got to come with profitability, and I think we've sort of performed there as well. So in 2020, we lost the least of any airline in the U.S. In 2021, we were the most profitable airline. In 2022, we were among the most profitable when you aggregate some of the low-cost carriers, we're the most profitable. We were actually second that year, and that's because we signed a new pilot deal at the end of '21 and had to absorb those costs. This is 2023, so again, the most profitable airline in the U.S. with about a 10% pretax margin. So we have a demonstrated track record of revenue growth and consistent profitability since this new model was put in place. This is our scheduled service route network. We operate to a lot of different destinations. Our main hub is in Minneapolis. So most of our flights are, let's say, 60% of our flights originate there. We have a -- we are -- we uniquely schedule the airline. We are 100% leisure and our schedule is very peaked. So unlike, let's say, some of the other low-cost airlines, let's say, Spirit, Frontiers of the world, which focus on high utilization, driving CASM down as low as possible, we have much lower utilization, and our model is designed to maximize unit revenue, and we keep unit costs low through this diversification across different business segments and just good cost control throughout the company. So in the fourth quarter of 2022 -- 2023, we had negative year-over-year adjusted nonfuel CASM. We expect CASM to say to stay on a good trend in the first quarter as well. So costs are well within control in the company. This is a little bit of a description of sort of how we schedule the airline. So this is Spirit, Frontier in the green and black lines. And it is basically the monthly variance in the amount of seats that they fly. We are the orange line. So we fly the airline really hard during our peak quarters like Q1 and peak months like March, where we have about 60% more ASMs in March than we do in January. In September, our slowest month, we pull way back in scheduled service. Charter is larger and the Amazon business stays very steady. So again, I think it's a very unique model as it says here, 118% more ASMs in March than in September. I think there's maybe one other carrier that does something similar to this, but it's definitely unique. So this is exactly what this model is intended to do. We sacrifice a little bit on CASM since we have lower aircraft utilization, but we more than make it up on the TRASM front. So this is 2023 unit revenue where we let our low-cost peers, you can see where we are from a CASM perspective, and the important thing is the differential between the 2, where we led our peer group. So as I said before, the airline focuses on Minneapolis. We have a lot of other point-to-point stuff we do as well, but Minneapolis is our biggest market. Since 2018, we've gained about 8 share points. And I think the important thing about this slide is this has not come at the expense of the largest airline in Minneapolis, which is Delta. They've actually picked up share over this period as well. We both have gained share at the expense of all the other carriers in the market, particularly LCCs who've gotten considerably smaller here over the last 5 years. From an ancillary perspective, we focused on this at the beginning. We've really driven ancillary performance from probably $21 per passenger, up to the numbers [indiscernible] $66. We think that there's probably $3 to $5 more per passenger. We aren't as sophisticated as we should be at sort of merchandising ancillary products or optimizing the price of our ancillary products or selling sort of bundles with rental car companies or hotels. We're very focused on that, and that should drive additional value here in the months and quarters ahead. Our charter business, so this is sort of the second segment of the company. About 80% of this business is under long-term contract to several customers. So 3- to 5-year deals at fixed pricing. It's a very profitable business for us. And again, the important thing about this business is it is integrated fully into our scheduled service operation. So we'll fly a scheduled service leg, a charter leg, another scheduled service leg, and it maximizes profitability of the whole trip. These are some of our customers here. So we are the charter provider for Major League Soccer, Caesars casinos, you can see the other ones that are here. The important thing is the charter customers that we do not have are NFL, Major League Baseball, anything that requires a custom configuration is not something that we want to pursue. These aircraft need to be able to -- they have 186 seats. They need to be able to circulate through scheduled service and charter very seamlessly. This is just sort of an example of it here. So the blue segments are scheduled service segments. The Charlotte Fort Lauderdale segment is an MLS segment. So essentially, if we were a standalone charter carrier, the method we would use to service this flight would be dead heading the aircraft from wherever our base was to Charlotte, picking up the flight from Charlotte to Fort Lauderdale, waiting, taking the team back to Charlotte and then deadheading a segment back to wherever our home base is. Our methodology is we sell the mini Charlotte segment, which made on its own, not be a very profitable segment, but it's completely additive to the charter segment from Charlotte to Fort Lauderdale. So we'll fly a triangle pattern like this. If this piece of business, in particular, was done by a stand-alone charter carrier, you probably have about a 5% margin. With us, it's about a 20% margin. Our cargo business, we entered into this in December of 2019. So right before COVID, which was highly fortuitous timing for us. But we brought this in the beginning of '19 -- or sorry, beginning of '20 and grew it to 12 aircraft through 2020. It is a great business for us because unlike -- several things, unlike the peakiness of our passenger business, this is very steady, very similar each month throughout the year. So the amplitude of sort of our scheduling is dampened a lot by the fact that the cargo business is very flat. Again, it's the exact same pilots. The other beauty of this business is, it is completely asset-light. Amazon owns these aircraft. They sublet them to us at basically no cost. So we've had to put minimal capital into this. We get paid on a per block hour basis regardless of how many boxes are in the back of the plane. It's crew, maintenance and insurance is what we pay. I think there will be an opportunity to grow this business going forward, but it's a very valuable piece of the company. Sort of looking forward here a bit. Our fleet, as I said, 54 aircraft in 2023. '24 and '25, we've grown the scheduled service business a little bit. But we have these 7 aircraft that are now on lease to 2 Middle Eastern carriers that are coming back. That will be our fleet growth in '24 and '25, '26 and beyond is probably 70-plus aircraft for us. Between these 7 aircraft that are coming and some improved utilization on the rest of the fleet, we think we can grow the airline 30% to 40% with no additional capital requirement. So if you look at our free cash flow generation in 2023, it was significant. We bought back about $100 million worth of our shares, which for us is a significant piece of the company's float. And in '23, our total CapEx spending was about $220 million. It will be less than half that number in 2024 and 2025. So we generate significant free cash flow. The balance sheet I'll talk about in a second is very strong, and it's just a matter of capital deployment at this point. This is the balance sheet here. The company has got about -- liquidity equal to about 20% of our revenue. Again, I think we can operate with probably a lower level of liquidity than this, largely because of a significant chunk of the business, the charter business, and the Amazon business, a very fixed level payments. So there's not a lot of variability like there would be on the scheduled service side of the business. The other thing about those 2 segments that's important is we are fuel neutral. So Amazon pays for the fuel cost for the cargo business, and there is a true-up for fuel costs in the charter business. So we like to think that about 30% of our fuel consumption is perfectly hedged without us having to enter into any hedging contracts. On the balance sheet side, we've been delivering -- delevering the business consistently. We finished '23 with net debt to EBITDA of 2.2x. By the middle of this year, we should be below 2x and well below 2x by the end of 2024. So just to reiterate, this is sort of the description of our model, high growth, high margin. Businesses are very synergistic. Again, we cross utilize our assets. very resilient through the business cycle. Charter and cargo businesses are recurring revenue streams, solid balance sheet and superior unit profitability. So we're really excited about the company. I think the trend has been -- the results sort of speak for themselves over the last 5 years, and we'll continue to look forward and grow the company.

All right. Sounds good. James you want to tick off. You can...

You mentioned a 30% to 40% growth. You guys have talked about pilot upgrading [ issues ] just what inning would you say we're in of that issue being resolved? And I guess over the next 2 years of the buckets that's scheduled and chartered what do you -- what's the growth profile of those 2 businesses from a capacity perspective?

Yes. So basically, let me just describe the issue. We were having difficulty attracting pilots and we're seeing a lot of turnover in 2021, like the fourth quarter in particular. We signed a new pilot deal in December of '21 and attrition dropped pretty drastically and hiring ramped up. The biggest constraint on our growth has been captain upgrades, which is literally having first officers upgrade to captain positions and there's a number of reasons for that: lower-quality trips if they're junior captains than they are seniors FOs. I think another aspect of this captain upgrade issue has been guys coming to a company like ours and thinking that they are going to flip over to Delta, United, Southwest when the opportunity came up. And with the big cutbacks and hiring that these guys have announced, there's a lot more people hanging around and upgrading. So we're probably 3/4 of the way through that problem. Let me put it this way. If we had all the captain upgrades we wanted, we probably wouldn't be growing that much faster than we have been. So we'll grow block hours, '24 over '23 by around 10%. Almost all that growth will be dedicated to the scheduled service business. So 15% ASM growth kind of a thing.

Got you. your low-cost peers, even American last week talked about the reallocating capacity out of oversupply markets into underserved markets. I think Minneapolis is still down from pre-COVID in terms of capacity originally out there. Would you characterize Minneapolis as underserved? And also, are you seeing any competitive pressures there from next 3, 4 months from low-cost carriers that are reallocating capacity.

I mean the trend has been ULCC is kind of pulling out of the market. I think we've seen some, let's say, sporadic people coming in and then going out quickly. So there hasn't been that much of a notable change in sort of the tail end of March, let's say, the last couple of weeks. We've seen a little bit of softness in the Caribbean and Mexico, probably largely driven by the fact that there has been significant capacity increases there. But no real drastic ULCC penetration. The other thing is the airline is designed to move airplanes around. So in the summer, we take aircraft out of Minneapolis. We put them in Dallas and fly from Dallas to Mexico and to the Caribbean. We were flying LAX to Honolulu in June, July, August and then absolutely out of that market. So we can move the fleet around in a very nimble way to take advantage of where the opportunities are. And if we don't think that they're scheduled service business available, we'll park aircraft or more preferably will pursue ad hoc charter stuff. So like the U.S. military, college sports before so much of our business became contracted business, we would pursue a lot of that. That's become much smaller, but the market is still there. So as we -- as the pilot situation solves itself, and as we grow, we'll be able to pursue more of that ad hoc stuff. So it's really the flexibility of the model and the ability to move resources around that, I think, is the strength of the company.

Thanks for the presentation. Question -- the 20% market share in Minneapolis jumped out at me in part maybe because of my legacy being in Northwest and I know how they competed. But my impression of Delta is that they're a pretty aggressive competitor. You did cite that others have exited the market. during this period. But like are you tapped out in terms of Minneapolis growth? Like is there a number that you don't want to exceed unless you incur the RAF the widget?

Yes. So this is passenger share. If you looked at revenue share, we'd have similar growth, but Delta would have a bigger piece of Minneapolis.

Fair point.

I mean I think just in my view, from the Sun Country side, but I think we compete fairly well with each other. We do not trash the fare structure. We don't come in and offer ridiculously low fares at which no one can make money. We're very disciplined pricers. We understand sort of the environment we're running around in and what we can and can't do. A 100% leisure focused, a 100% focused on picking up peak demand periods. So is there some sort of a cap? Probably, I don't think we're there yet. But the nature of where we will continue adding capacity to Minneapolis is in peak periods when there's very, very strong demand.

And then a second question, so you hope to grow the Amazon business from the $100 million or so, 10% neighborhood where it is now. I assume that might work like so much else works in the industry. Amazon would put out an RFP, you would bid, others would bid, who are you going to compete against other than Amazon Prime, for the next tranche of capacity that they want to outsource to somebody?

Well, let me just sort of....

Or is it just yours for the...

Yes. I mean here's the deal. So we are Amazon Prime. Our aircraft basically, say, Sun Country in a little bit tiny letters, they're all painted with the Amazon Prime livery. So basically, Amazon has a number of -- they don't operate any of their own aircraft. They have a number of providers in the U.S., ATSG, Atlas, us, Hawaiian is now doing some A330s, yes. So we're not going to introduce a wide-body fleet type. We're not going to compete for that business. The question is, are there -- is there more 737NG flying that we can do for Amazon. We think there is that either comes through growth in the Amazon fleet or share shift. And we're indifferent as to where that comes from.

And you're the only ones doing 73 cargoes?

The -- so there's 20 737NGs flying around the U.S. for Amazon. We have 12, Atlas has 8.

All right. Thank you.

Dave, question for me. We heard a lot this morning from Delta and United about the power of the brand, air travel is not a commodity and the success that they've had, obviously, going upscale. And of course, we spent a lot of time with everyone talking about loyalty and unlocking the potential of that for the bigger guys, especially. How do we think about that from your perspective, given your customer base and your size? And the fact that this room here is being -- I don't want to say brainwash, but we're being fed right this line, that brand and non -- anti-commoditization of travel and so forth is so important. Given how you fly the markets you serve, how you pull capacity up and down and so forth, does it just not matter to you? Does it matter and it's something you're working on? How should we think about it?

The world isn't just Comfort Plus and first-class travelers, right? So the vast majority of passengers are still flying in basic economy or are price sensitive. That's our -- the market that we go after is families going on vacation; individuals, visiting friends and relatives. That is a price-sensitive market. And our -- we put all new interiors in these aircraft. We put all new interiors in every aircraft. We buy the product is nice. We've got larger pitch than our competitors. We've got a streaming Wi-Fi system on the aircraft. We think we are -- we have a nice product. Again, we don't trash fare structures. I would agree that there's differentiation we think we're differentiated from a product perspective relative to other ULCCs. But the other thing I'd say is there's a lot of talk about the diversification of revenue streams, whether it's a loyalty program, whatever it is, we are the perfectly diversified carrier. We have literally 3 different segments that we operate through that have very different characteristics. The beauty of it is the assets used to service these 3 segments are the same. The pilots are the same. The back office is the same. We can keep our costs low. We have a diversified revenue stream. It might not be because we have a huge loyalty program, but it's because we have different business segments.

So is scale then not as important to you or the need to grow not as important to you, whereas you can more selectively just like you fly the network hard and soft and so forth and you take down capacity, should we think about that when we think about your growth aspirations is what you're saying, meaning that you'll grow if you want to, but you don't have to.

I think it's -- we want to grow the airline. Do we necessarily need to grow the scheduled service segment? Not necessarily. We can grow our Charter segment. We have abandoned a big chunk of ad hoc charter over the last 3 or 4 years because of the pilot issues we've had. As those solve themselves, all that business is still there, and there's probably fewer competitors chasing it. That's an opportunity for growth. If we grow our Amazon business, that could be significant growth, and it could keep us occupied for a while. So we want to grow the airline. If the scheduled service business is -- we're not slaves to growing that business. We want to keep growing it. We think there's opportunities to do it. We'll put resources in the other segments to keep growing the airline.

Anyone from the front row...

Do you have an update on the market for used aircraft the type that you have and then any maintenance cost trends on some of the older aircraft?

Yes, that's a good question. So I would say in the last 18 months, used aircraft values have really firmed. So sort of during COVID, right after, we were buying a lot of airplanes at really cheap prices. That has firmed up. It's probably the firmest I've seen it right now. As I talked about before, all of our growth is basically in the pipeline. The aircraft that are coming to us, we've already purchased. They're on lease to someone else. They're coming to us. We do not need to be active in that market right now, and we probably won't need to be active in that market for at least 2 years. So we'll see where this sort of shakes out. Someday, I assume some of these aircraft delivery constraints will loosen and then used aircraft prices will get low again, but they are firm right now, but we don't need to be buying right now. From a maintenance cost perspective, there's no doubt that maintenance costs have gone up. Both piece parts and MRO rates are higher. We have had an active program now for 3 years, where we have been buying up green time engines in the market. We haven't done overhaul of an engine in at least 2 years. We have a stable of green time engine so we can avoid overhauls of those engines for the next couple of years easily if we don't buy any more engines. From the airframe perspective, much lower cost on an engine overhaul, but we have seen cost pressures there. We've actually shifted more of our business offshore this year to sort of offset that a bit.

So if I put myself into the position of running one of the money-losing discount franchises in the United States. And I'm sitting here listening to your presentation. Naturally, I'm going to think, I got to give me some of that Amazon business. I got to start looking at charters. I don't think pivoting some of those more challenged business models would be easy or even feasible. But sometimes, managements do things that are not easy or feasible. Do you worry about others trying to muscle in on the uniqueness of your business model given the challenges that they're facing? Or can they just find some other way to put their houses in order.

I think on the first part of the question is it's a -- this is a fundamentally different business. If your business is focused on driving unit cost as low as possible, you need to utilize the aircraft 12 hours a day. You know what I mean. So to sort of suddenly say, hey, we're going to become a charter airline or we're going to go into the Amazon business and our utilization is going to be 7 hours instead of 12 hours a part of the fleet, that seems to me anyway, to fundamentally undercut sort of their business plan. They got brand new aircraft, a lease rates in many cases, so they've got to keep it sort of flying. We're mid-life 737s. The average age of our fleet is 15 years old. We are in the market midlife 737NGs. So low capital cost as possible. And since the utilization is low, the operation runs just fine. In terms of fixing the business models, I guess that's a whole other discussion.

Is the growth in the cargo business constrained by how much Amazon wants to grow? And how have those trends been post COVID? Is it like normalizing because e-commerce was doing very well during COVID or is there still steady growth there?

So I mean we could pursue other cargo business. We haven't nor do we have an intention to in the near term, Amazon is a great customer. If we grow the cargo business in the near term, it's going to be with Amazon. And that can come through them growing their fleet or share -- or shifting aircraft around their fleet. So the growth could come in sort of either direction. If there was a softness in the Amazon business, I think the way it would affect us is there'd be fewer flying hours. So they would bring the number of block hours that we fly these aircraft down. And if anything, it's been going in the other direction for at least 2 years. There's a lot of discussions between us and them about the schedule. They want to maximize these aircraft, and I've seen no pullback.

Could you please speak a little bit to the -- just the culture of the company. I think going back a number of years, it was a family-owned company and how that's changed as you transition to a public company?

I mean I think the culture of the company is very nimble, very, very cost focused. We have to be with this model. Since 2018, the entire senior management team has turned over say for one person, and that sort of trickled down through the whole organization. I think the management team understands the model, understands what we need to do, understands that we need to keep our costs as low as possible. So I think it's -- I think the culture is very well suited to the kind of business that we have to execute.

All right. Thanks very much.

Thank you.