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

Welcome to the Sun Country Airlines business and Second Quarter Update. My name is Josh, and I will be your operator for today's call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I will now turn the call over to Chris Allen, Director of Investor Relations. Mr. Allen, you may begin.

Thank you. I'm joined today by Jude Bricker, our Chief Executive Officer; Dave Davis, President and Chief Financial Officer; and a group of other staff to answer questions. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that constitute forward-looking statements. Our remarks today may include forward-looking statements, which are based upon management's current beliefs, expectations and assumptions and are subject to risks and uncertainties. Actual results may differ materially. We encourage you to review the risk factors and cautionary statements outlined in our SEC filings. We assume no obligation to update any forward-looking statements. You can find our press release and the accompanying presentation on the Investor Relations portion of our website at ir.suncountry.com. With that said, I would like to now turn the call over to Dave.

Thank you, Chris. Good afternoon, everyone. Thanks for joining us on the call. Our intent today is to update our investors and analysts on our revised Amazon agreement, provide a very high-level look at our growth plans over the next couple of years and update our outlook for Q2. First of all, we're very excited to announce that we've entered into an amended air transport services agreement with Amazon. For this agreement, we will grow our cargo fleet by an expected 8 additional aircraft and extend the term of the agreement to 2030 with additional expansions possible through 2037. Amazon has been a great partner of ours since 2019, and we look forward to continuing this relationship well into the future. This expanded agreement reflects Sun Country's unique business model and, importantly, our diversified revenue streams, and we expect our growth in 2025 to be focused on our cargo segment. On Thursday morning, we 8-K'ed a short presentation to accompany this call, which is also available on our IR site, as Chris mentioned. Let me just briefly walk through the slides, then I'll open the call for a few questions that Jude or I or others can field. First of all, starting on Page 3 of the presentation. This is a look at the major terms of the agreement. We think this agreement provides some key benefits for Sun Country. First of all, as I mentioned, we're expecting to take 8 incremental aircraft, and we're expecting to take those aircraft in 2025 with deliveries to us in-service dates, let's say, starting at the end of the first quarter and extending through the third quarter of '25. When you add the 12 aircraft we now have, this brings our total freighter fleet to 20 aircraft which we hope to be at by the end of '25. Also, as I mentioned, we extended the term of the agreement. So the base agreement is extended through 2030. And then there's a couple of extension options in there that can take the agreement all the way out to 2037. I think really importantly is with this new agreement, we sort of achieved balanced economics here, and here's what I mean by that. So we expect on a steady-state basis once fully ramped towards the, like I said, third, fourth quarter of '25, that the contribution margin of the Amazon flying will be basically on par with the contribution margin of our passenger flying on a historical basis. So by that, we mean basically our 2023 passenger margins, the contribution of that business, we expect to be similar to our Amazon business going forward. So this is indifferent between Amazon and the passenger business to decide which segment we grow in, and we've achieved these improved economics. And then really importantly, as we look forward here from a CapEx perspective, as with the 12 aircraft we have, there's no CapEx required to grow this fleet because the aircraft are controlled by Amazon, and we operate them for Amazon. Turning to Page 4. So where are we going to grow over the next couple of years? This is what our preliminary numbers look like. So in 2025, we expect all of the growth resources that we have to be dedicated to the Amazon business. So we expect -- depending on exactly when the aircraft show up, we expect let's say, 60% to 65% growth rate in our cargo business next year and then 13% to 15% in 2026, really due to just the annualization of the '25 growth. What this is going to necessitate is a reduction in the size of our scheduled service segment in 2025, which we estimate to be between 10% and 12%. And then we'll begin growing that business again in 2026, which very preliminarily at this point, we expect to grow by 6% to 8% in 2026. Now a lot of that reduction in 2025 flying will come in off-peak periods and be our most marginal flying. So we're expecting significant unit revenue improvements in 2025 for our passenger business. We sort of think that's really important at this point. If you look at this graph that we have on the bottom of the page, what we did here is just plot ASM growth between 2023 and -- between 2019 and 2023. And then our TRASM growth over that period as well for all these carriers. As you would expect, sort of the slower more methodically growing carriers have produced outsized TRASM growth, and that's especially the case for Sun Country. So we expect to get back to this measured growth over the long term in our passenger business after some pretty rapid growth in 2025. As I mentioned, lower right-hand side, we're expecting significant TRASM improvement next year, and there's been a lot of growth this year and a lot of capacity added to the domestic market. Finally, on Page 5. Q2 results. This is what we're expecting at this point. So our previous guidance was revenue of $255 million to $265 million. We're tightening that up a bit towards the bottom end of the range here, $255 million to $257 million for the quarter. Fuel is coming in a bit favorable. We're expecting operating margin to be between 4% and 5% for the second quarter. And then our tax rate and our -- the size of the airline is expected to be about the same as it was when we gave the original guidance. I think also importantly to note is we're expecting and we continue to expect favorable year-over-year CASM for the third straight quarter. So in the fourth quarter, the first quarter and now the second quarter, we're expecting our adjusted CASM ex to be favorable on a year-over-year basis. So that's the slides. Again, we just wanted to update folks on this new agreement and what our longer term is looking like. And happy to take a few questions.

[Operator Instructions] Our first question comes from Duane Pfennigwerth with Evercore ISI.

Congrats on this expansion. Can you talk about if there are any start-up costs? And if there is such a thing like the network for cargo, how will your cargo network line up with your existing passenger network, any need for like new potential basis?

Yes. So I think we expect some start-up CapEx, but we expect it to be pretty minimal, like, for the total aircraft things sort of low-digit millions from a CapEx perspective. So it's very small. We don't have final schedules yet. We'll see where they want to supply the aircraft. We're hoping that maybe it produces even sort of more efficient schedule since we have a greater mass of aircraft. From a basing perspective, again, I think we've -- we'll sort of make some decisions on that as we get more clarity on the schedule, which we just don't have yet.

Okay. Great. And then I'm sure some clients have already backed into this from the slides you gave, but can you give us a sense for overall kind of system block hour growth expectations in 2025 and 2026? And maybe for those same years, how we think about the mix of earnings from cargo? Specifically, what percentage of your EBIT, for example, would that represent?

Yes. So first of all, from a growth perspective, I think it's our objective to sort of continue to grow the airline on a high single-digit, low double-digit year block hour number. That total growth may be a little bit slower than that in 2025, maybe mid- to high-single digits from a block hour perspective with all of that and more dedicated to the cargo business. Then after that, as we get back into sort of '26, it's probably that high single, low double-digit block hour growth for the fleet. We're not going to get into a ton of the financials yet, but as I mentioned, we wouldn't be taking on sort of this additional flying if it wasn't as profitable as our historic passenger business, our scheduled service business in particular. So you could probably do some rough math around that. It's a little bit premature for us to get into the details on the call, but we're expecting significantly improved contribution from the cargo business going forward.

Our next question comes from Ravi Shanker with Morgan Stanley.

Dave, I think this happened a little bit quicker than we were expecting, just given the original contract time line. So can you just unpack a little bit of how long has this negotiation taken? [indiscernible] hard to come about? And was it, Dave, a function of some recent changes that Amazon was seeing and some of the other contracts? Or has this discussion been going on for some time?

Yes. I mean I would say the discussion as to the ultimate fleet size has been going on for an extended period of time. As to Amazon's exact motives as to why there's a certain number of aircraft for certain providers, it's a little bit unclear, but specific negotiations around this particular expansion, I would say, have probably been underway for probably 6 months, maybe a little more than that with more intensity in the last 2 to 3 months. It's our belief that Amazon is focused on reliable service above all else to serve their customers. So we think we've demonstrated that over the years, and we've been rewarded with these additional aircraft we believe because of it, they're our most important relationship at the company, and we want to continue to provide that level of service as we go forward. And we're just gratified that we have these additional 8 aircraft to fly.

Understood. And just a follow-up on that point. Are you locked in on the fleet size? Or is there opportunity to expand beyond 20 during the life of this contract if Amazon decides to get deeper into narrow-body?

There's no lock on the fleet size. I think we've talked before that Amazon operates 20 narrow-bodies in the U.S. at this point. So we expect to be operating all of those. If they grow the fleet in the future, we would definitely hope to be considered for further expansion. I think that's a function of our performance, which we intend to continue to perform on. But there's no hard cap or anything like that.

Our next question comes from Helane Becker with TD Cowen.

I'm assuming this is going to be operated the same way as the existing is with no additional pilots required or anything like that, just integrated into the existing business.

Yes. I mean it will be integrated into the existing business just exactly the way it is now. I mean we won't have a segregated Amazon pilot core or anything like that. The strength of the model is diversification and cross-utilization. So we expect to fully continue to be doing that into the future. We'll need more pilots just because we're growing. So whatever growth resources we have as we move into '25, they're going to be dedicated to the cargo business, and then we'll get back to scheduled service growth after that, but we'll need more pilots because the airline is bigger.

Okay. That's very helpful. And then my other question is, I don't know if you can answer this right now, but it's on warrants. I didn't see anything in the document yesterday that talked about warrants changing. So can you maybe walk us through the value of the agreement? And -- or did you issue more warrants and I just missed it in my reading?

Yes, you didn't miss anything, Helane. We didn't issue any more warrants as part of the agreement.

And so how should we -- okay, so then the value of the warrants just are the same as they were before as if this change didn't occur? Is that how we should think about it?

So this is the way that -- at a very high level, the warrant agreement works. So we granted Amazon a certain number of warrants in 2019 when we signed the original deal and that's accessible. You can get that number. Those warrants vest based on the amount of revenue that we get from Amazon. So it's fair to say that the vesting of those warrants will go faster because we're getting more revenue, but the number of absolute warrants issued is unchanged. That's how I would say it. Now they vest fairly slowly. They'll continue to vest fairly slowly, but at a bit more rapid rate than they have been.

Our next question comes from Michael Linenberg with Deutsche Bank.

This is Shannon on for Mike. Two separate ones. On the revenue guide down, I know it's very slight this quarter for the second quarter. But is there anything that we should read through to demand on that? Or is it mostly just from an overly competitive landscape?

Yes. I think some of the fair pressure that we saw and talked about on our first quarter call essentially continues. I mean there's been a fair amount of capacity added, some of it by us. There's been fair pressure. I think it's a function of both capacity and just a sense of maybe just a general slowdown, a slight weakness in demand for sort of our consumer. Planes are full. Fares are down a bit. So thus the sort of lower end of the range.

Shannon, I'll add that the capacity backdrop as you go through the rest of the year, that's improved. So we're kind of at max capacity year-on-year growth into the second quarter at 10% overlapped on our network, and then that improves into the back of the year dropping into low single digits.

As for my second question, on future uses of free cash flow generation, and I know that this Amazon contract is definitely going to boost that, are you planning for a new share repurchase program or accelerated debt paydown? I know that your balance sheet is in great shape, but anything on use of cash here would be helpful.

Yes. So as we mentioned, our CapEx burden is a lot less in '24 than it was in '23, and we expect it to continue to low into '25 and '26. We bought back probably 12%, 10%, 12%, 13% of our float in the last 1.5 years or so. We sort of exhausted the last of the authorized buyback in March. I think as we sort of look at the back half of the year, look at the revenue backdrop -- yes, the revenue backdrop, we'll make some more decisions on that. But it's fair to say that with our surplus cash, it's either going to be more share buybacks or maybe some debt paydown, but we haven't sort of firmed up on that yet.

Our next question comes from Scott Group with Wolfe Research.

So I just want to follow up on the comments around contribution margins getting in line with passenger. I'm guessing there's -- some of this is apples and oranges, but in the K, right, you talked about in 2023 passenger operating margins were 14% and cargo was negative 5%. Is that sort of directionally -- when you talk about contribution margins, is that directionally the way to think about it, that there's like a 20-point improvement in cargo margin to go from -- in line with passenger?

It's not quite that linear, but I think if you do sort of -- off the top of my head, if you do kind of that rough math, you're going to get pretty close to what we would expect a steady-state improvement to be in the bottom line, let's say, by 2026. The issue and why it doesn't maybe not show up that way in the financials is we allocate overhead. Some of that overhead is allocated based on the number of aircraft. Some of it is based on block hours. So it may not sort of appear exactly that way. Let's say, once we get into '26, but the overall magnitude of the, let's say, the contribution to the overall airline from the math you're roughly doing in your head, it's probably not that far off.

And so when you think about the net of it -- a lot more cargo next year, less passenger, right? RASM accretion from last off peak, right? Is the net of it, in your mind, better margin in '25 than '24?

Our preliminary looks are substantially better margins in '25 than '24. Yes.

Okay. Helpful. And then any way to just put some directional color on that RASM accretion comment on the passenger side?

We say in the presentation here, and part of this is -- let's say -- let me say it this way. Let's say, all else being equal because clearly, a lot of what's happening in the revenue environment is not directly Sun Country related, and it's just the backdrop. But if we're looking at a total reduction in block hours on the order of 10% to 12%, it probably translates into RASM improvement on the order of, let's say, high single digits, let's say, 8% to 10% kind of a number. And again, this is ex the outside environment, just -- we'll pull out a lot of unfavorable capacity or a lot of unfavorable flying.

Scott, it's Jude. I just want to make the point, '25 will be special because the airplanes for cargo start to show up in the second quarter. So our first quarter will be benefiting from growth. We're going to grow 10% of our block hours. Those block hours will be allocated in the scheduled service in the first quarter. And then our scheduled service will be reduced in the second and fourth quarters. So we have the seasonality benefit of the cargo growth in '25 in addition to what Dave's talking about.

Your point is your Q1, that's always your seasonally best, doesn't see any of the reduction in passenger?

Yes, precisely.

Passenger block hours.

Seasonal mix for scheduled service in '25 will be better than in '24. Yes.

Okay. And then just last one, if I can, just near term, just given the Q2, how should we think about just the normal seasonal Q2 to Q3, if you have any initial thoughts there?

Normal seasonally between the 2 quarters, to go back and look historically, probably not that much different. September is the worst month for the company. So maybe a touch worse, would be sort of seasonal 2% to 3%.

[Operator Instructions]. Our next question comes from Christopher Stathoulopoulos with Susquehanna Financial Group.

So 2 questions. Just if you could remind us with the CMI leases, whether there are utilization minimums. And then also the visibility to flight schedules for Amazon. So is it where you get schedules week of, month of, just how much visibility do you have into what a typical month or quarter flying and utilization might look like?

Let me take the first part on the CMI leases and then Greg can talk about the second part. So there's no utilization minimums, but the contract is structured in such a way that there's both a per aircraft and a block hour component to how we get paid. So functionally, there's sort of a minimum because there's simply a per block hour number -- I mean, sort of a per aircraft number, which kind of serves as the floor. So Greg, on the schedule front.

Yes. On the schedule front, Chris, this is Greg Mays, we get those schedules much in advance. We actually have the opportunity to work with Amazon to make them more efficient. So I think we're probably talking 4 months out as we're working through schedules. So we get a lot of advanced notice on those.

So we'd probably expect the first schedule with the new aircraft in it sometime in the fourth quarter.

Okay. So next time this year, then you would have at least an early read by, call it, August, that time frame for what peak might look like -- peak season?

You mean you're talking about like when we get our first look at the new Amazon schedules?

Right. So for instance, if we're fast forward next August at this time, July, you would have at least a kind of a preliminary flight schedule for Amazon with what fourth quarter peak flying or fourth quarter utilization might look like.

Yes. So think like 3 to 4 -- like 4 months before the quarter starts.

Thank you. I would now like to turn the call back over to Dave Davis for any closing remarks.

Thanks, everyone. As I said at the top of the call, this is an exciting time for us. A lot of good things happening at the airline, and we appreciate everyone joining, and we'll talk to you again after our -- for our second quarter earnings announcement. Thanks.

Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.