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

Good morning, everyone. Welcome to day 3 of the Bank of America Annual Transportation Airlines and Industrials Conference. Kicking off this morning, we have the team from Sun Country here, and thankful to have their Chief Financial Officer, Dave Davis with me. So Dave, welcome to the conference.

Thanks. It's great to be here. Appreciate it.

Yes. Sure thing. We heard from some airlines yesterday, obviously, just from the investor community, the focus remains on demand. We heard from Alaska, Air Canada yesterday. Just premium still seems to be relatively strong. Yourself, some of the other ultra-low-cost carriers reported over the last week, 10 days, a little bit softer coming into 2Q than maybe people would have thought. Can you maybe give us the status of what you're seeing from the demand environment right now?

Yes. I mean, first of all, if you look at our numbers, I mean, we had a very strong first quarter. We had an operating margin of 18%, which I think I don't know where the next closest airline was, but probably 5% or 6%. So I mean it's a very outsized performance for us in the first quarter. So we continue to lead the industry. I would say from an overall demand perspective, here sort of is where things sit from our perspective. So at peak periods, which is where the airline specializes, demand continues to be very strong, there is strength on the fare side. So those are performing really well. This story of great peak period demand and weaker off-period demand, I think, is persisting. So we sort of saw, let's say, late February, early March, a little bit of an inflection in off-peak fares. In other words, sort of a downward drift. That took our March numbers down a little bit lower than we had originally expected. Going into the second quarter, I think sort of that pricing price pressure persists. So the airplanes are full. We're able to set to fill the aircraft, fares are a little softer than we had expected initially going into the year, particularly at off-peak times. The airline specializes, as I said, in focusing on peak periods, less capacity in off periods. In the second quarter, we probably have a bit too much capacity dedicated to off-peak periods. We'll correct that as we go into the back half of the year, we're making schedule changes sort of as we speak. But I would say there's a lot of capacity in the market right now, in the domestic market anyway and a little bit of fare pressure out there.

Got it. I guess this peak versus off-peak dynamic, I don't like -- is it new? Or is it just getting -- do you think it's just getting worse? Because I feel like it's certainly been kind of part of the conversation for the past year or so. Just curious, is it -- are you just seeing that dynamic happen now? Is it -- at this point in time, it's just getting worse, and just like why do you think there's too much capacity in 2Q? Because I do feel like this has been a common theme.

I don't think this trend is necessarily new. I think we and others have been talking about it now for probably a couple of years and since post-COVID. It definitely seems to be persisting, maybe even getting a little bit more exacerbated. But I think it's hard to completely dissect how much of this is demand weakness and how much of it is just a lot of capacity. So in some of our markets in particular, some of the Caribbean markets, Florida, there's just been a lot of capacity added and that's had an impact on fares.

When you think about your consumer, maybe the kind of the income cohort that Sun Country focuses on, how do you view the health of that consumer? And maybe do you think there's just a lot more price elasticity from them than, say, maybe other areas of travel?

I mean they're still taking vacations. So if you look at our first quarter results, you can see that people are still traveling during holiday periods. But as I said, there's probably a bit of softness in some of these off-peak periods. So maybe it's the sort of discretionary trips that aren't happening as often as they were. Again, it's difficult to disentangle a lot of capacity in some of these off-peak periods with -- disentangle that from sort of the demand environment. I think sort of the revenge travel phenomenon is kind of over. We're at sort of a steady state at this point. That's how we view it. Our unit revenues are now consistently about 20% higher than they were in 2019. And that seems to be kind of where they're persisting and where they're settling out. Yes.

Okay. When you talk about too much capacity in the market, obviously, you're largely Minneapolis obviously go up against Delta. Are they -- like what's the competitive dynamic like there? You seem to have lived in harmony for with them for quite some time. How is the competitive landscape changing now, if at all?

Yes. Let me just step back for a minute because I -- sometimes we end up going down the scheduled service discussion in sort of all the analyst meetings, everything we have. The airline has 3 distinct segments. We have a Scheduled Service business, we have a Cargo segment, we have a Charter segment. The Cargo segment and the Charter segment don't compete with these other carriers. They're different markets. Same aircraft types, different markets. So in the Scheduled Service business that is heavily focused on Minneapolis, largely because that's where we have success, the brand is known, fares are strong. The local economy is very strong. So that's where we've been focused from our Scheduled Service business. There has been capacity that's coming to Minneapolis over the last few quarters in excess of what it was before. I don't think -- there's really not any perceived sort of assault on our markets. In other words, I don't think that there's a concerted effort to do sort of damaged Sun Country. There's just an overall increase in capacity. And some of the markets that we have been in, particularly in some off-peak times have typically had relatively high fares even in off-peak periods. That sort of come in with more capacity at. Now I would say that I would -- I think in just recent actions that we've seen in the last couple of weeks, there's rationalization going on. Fares have come up a bit, capacity has come out. We will take some capacity out and the environment will sort of rationalize itself. Part of the capacity adds in Q1 and Q2 are us. We grew ASMs 16% in Q1 or grow 20% in Q2. So the airline is rapidly growing. That's going to have a natural down pressure on fares. As we go forward, we'll rationalize the back half of the year from a passenger capacity perspective and then decide as we move into 2025, where can we maximize profitability of the company? What segments should we be focused on? And I think we're actively looking at that right now.

Got it. So when you think about maybe the -- so you're growing a bunch in Minneapolis, what's the competitive growth like?

Competitors have grown too. So overall capacity in the first quarter in Minneapolis is up about 10% over -- or was up about 10% year-over-year, sort of similar numbers in the second quarter. So a fair amount...

And you're mid mid-teens...

And we're mid-teens. Exactly. Exactly. So others have added capacity to the market.

So is that capacity, does that -- out of Minneapolis, does that go into markets that you fly? Or are they going to maybe other leisure Sun Market destinations that just provide the consumer in the area, another option to go?

There's been a lot, and I think this is a consistent theme. There's a lot of capacity going into Florida which is a big first quarter market for us. The Caribbean, there's been a lot of capacity in there, a lot of capacity in the Cancun as well. So that's where a lot has been added. That said, capacity up 10%, we grew 16%. And we still posted an 18% operating margin. The earnings power of the business is there and demonstrated.

How do you think about new market growth, right? If Florida has too much capacity, too much going into Cancun, can you -- how easy is it for you to get into a new market without making stuff up, Vegas or Southern California or just provide a different type -- a different option for your consumer?

So there are opportunities to fly at peak periods in cities around the country. So there's a lot of opportunity out there for this model to focus on peak period flying, and we will continue to do that. The other side of the coin, though, is will shrink in off-peak times. This airline probably is going to generate, let's say, 8% to 12% annual growth from a block hour perspective. So then we have to make the decision, where is that 8% to 12% capacity growth going to go. Are we going to do more charter flying? Are we going to do more cargo flying? Are we going to do more Scheduled Service flying? To the extent we pull Scheduled Service flying down in off-peak periods that frees up pilot hours, it frees up aircraft. We'll do more flying in cargo and charter. So it's not necessarily that we have to go seek additional scheduled service markets to deploy our aircraft. It's additional Scheduled Service markets. What does the Charter market look like? What does the Cargo business look like?

Got it. And when you're -- and I'm speaking more to Minneapolis, but when you say you want to grow -- you can grow more in peak, less in off-peak. Do you have the physical infrastructure at the airport to add significantly more flying in the peak?

Yes, that's a good question. So the airline operates out of a separate terminal from Delta and other larger carriers. So we operate in T2. There's only a few of us in there, us, Southwest, a couple of others. So we have 8 gates there, ability to flex up to 10, 11, if we need to. There's enough physical infrastructure. But the reason that's a really important question is because not only is the airline serving peak periods of the particular months, but hours of the day. So we have a huge morning bank, a bunch of flights going out, let's say, to Caribbean, Mexico, Florida, coming back same time and then doing another turn. So we take a lot of gates at the beginning of the day and MSP is a great airport to work with, and we have no constraints from physical infrastructure right now.

Okay. If you have kind of a 2 or 3 incremental gates, just curious like every hour, how quickly do you turn those gates...

We can turn them very quickly, yes, very quickly. I mean, if we need them, we can basically move into them.

Okay. Yes. Got it. So you made an interesting point before just in terms of the decisions around Charter, right? So if I'm thinking about if you're pulling down maybe some off-peak flying within scheduled service. How easy is it to transition that aircraft to Charter? And kind of what are the growth opportunities within the Charter business? How quickly can you kind of pivot to that segment?

Yes. There's plenty of opportunity for growth in the Charter business. And let me sort of talk about this for a second. If you look at the size of our charter business, it's been relatively static now for a couple of years. What's happened is we have forgone a lot of the charter market, which is sort of ad hoc kind of flying, like military flying, the final 4 kind of last-minute sports team flying. But we have moved that capacity to long-term contracts. So about 85% -- 80% to 85% of our charter business now is long-term contracts. MLS, we have a big contract with Caesars. We have a couple of other contracts. That consumes all that. All that ad hoc business didn't vaporize. It's out there. The reason we haven't pursued it is we have been pilot constrained at the airline. The best use of the pilot resource has been grow the scheduled service business. That's what we've been doing, which is why let's say, we grow block hours 10% this year. We grow ASMs 15% or 16% because the black hours disproportionately allocated to scheduled service. We will move that capacity in that pilot resource back to the charter business as opportunities arise or to the cargo business. as opportunities arise. So there's still opportunity for growth there. We have sort of got out of a piece of the market, which we can move back into.

Got it. You brought up a topic I wanted to touch on just on pilots, right? From an industry perspective, this time last year, it was all about pilot constraints and not having enough and getting them through training and getting experienced to upgrade into the captain seat really across the industry. Obviously, a lot of things have changed over the past year. Other airlines are stopping hiring for certain periods of time, stopping new classes. I guess what's the latest from Sun Country in terms of ability to recruit, train? What are the kind of the continued pain points from a pilot perspective?

I think from a pilot perspective, it's mostly very good news. So basically, in terms of new hires, we have had -- there's not an issue. We've been sort of slowing classes because there's not an issue with hiring first officers and attrition has been at or below our expectations. So that hasn't been an issue. The governor for us continues to be captain upgrades. But we're probably growing right now at about what we think potential growth is. So we don't necessarily want to be growing much more rapidly than this. And our flight ops team has done a great job of utilizing the pilots that we have better. So we've done a lot of things to sort of reduce unproductive time. And we've been able to grow as fast as we want to grow, actually with fewer pilots than we thought we would need. So there's been a lot of work done on sort of the optimization side of things. But the pilots are not a constraint at this point on our growth.

Okay. So it seems like just across the cost structure, they were just the inflationary pressures have eased or become maybe more predictable than they were over the past couple of years. When we think about your cost structure going forward, where do you see the headwinds and tailwinds cost-wise?

So from a cost perspective, I think we're the only carrier or one of the small number of carriers. In the fourth quarter, we had a year-over-year CASM drop. In the first quarter, we had a year-over-year CASM drop. The cost at Sun Country are well in control. We did a pilot agreement that went into effect at the beginning of 2022. There's still a lot of time left on that deal. So those -- there's not cost headwinds there. I would say inflationary pressures have sort of eased across the rest of the company. So we're very happy with where we are from a cost perspective. And as I said, decreasing CASM is sort of where we want to be. As we roll forward, if we shrink the scheduled service business, that's going to have some upward pressure on CASM just because we have less capacity allocated to the passenger business. But overall, the cost picture looks really good.

That's what I was going to ask, as you maybe pivot away from -- if you move some flying from Scheduled Service to say, Charter or more of that ad hoc Charter, what would that impact be from -- I know CASM wise, but just margin perspective.