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

All right. Well, good morning, everyone. Welcome to Barclays second day of our 42nd Annual Industrial Select Conference. I'm Brandon Oglenski, Airline and Transport Analyst, and very excited. I think we're wrapping up our fireside here with Sun Country Airlines; and Dave Davis, Chief Financial Officer of the company.

Best for last.

That's right. And actually, you guys do have a very unique business model. I think we're going to get into here. But very quickly for those in the room, if you don't mind, 1 last time from my sector, at least let's do the audience response questions, and airlines have been more favorable at this conference than in past years. So do you currently own Sun Country overweight, market weight or underweight or no. All right. Question #2, we appreciate those that do participate, which are general bias towards Sun Country right now, positive, negative or neutral. All right. And then question #3, please. In your opinion, through-cycle EPS growth for Sun Country will be above peers, in line with peers or below peers. All right. Well, Dave, thank you very much for joining us today. I appreciate you being here.

Thanks.

I think for those that maybe don't travel to or around the Minneapolis area, might not be too aware of who Sun Country is, but small scheduled passenger airline -- I shouldn't say small, it's all relative, but about 40 aircraft on the scheduled passenger side and you're operating, is it 12 right now for Amazon?

Yes. The airline sort of by, let's say, the middle of this year will control about 70 aircraft. So it breaks down, there will be 20 freighters, about 45, 46 aircraft in the scheduled service fleet. And the rest are aircraft we actually own that we have out on lease to a couple of other carriers.

Okay. And I think we've covered you since the IPO, and Apollo just sold down completely. Is that right?

Yes. So the IPO was in March of '21, and they've been doing sell-down sort of gradually ever since in the last -- the last slug went out a couple of weeks ago, so they're no longer a shareholder.

Well, and I guess as we go on this journey, I think people still don't quite understand your business model, just based on the questions I was hearing on the last earnings call. Because I want to make very clear to folks here that you don't take risk on cargo capacity. That's literally contracted flying that you're doing for Amazon.

Yes, yes. Yes, so we still get questions about whether sort of cargo volumes up or down, how that's going to impact us? The answer is, it doesn't impact us. We operate today 12 going to 20 by mid-year, freighters all for Amazon. The business is not -- our compensation is not linked to the volume of material in the aircraft. It's driven by the number of aircraft we fly and the number of block hours we fly. So changes in demand would only affect us if it caused Amazon to take their schedule up and down, which hasn't been the case so far.

Right. And that's a long-term contract that you...

Yes. So we entered into this deal in December of 2019 right before COVID. And we now just extended it when we took an 8 additional aircraft. We extended it to at least 2030 with some potential further extensions built in.

And in this contract, you're literally providing the pilots and the operating authority, right?

It's really attractive flying for us. A, because it fits into -- it integrates really well with our passenger business because of the way the scheduling is done. But it is basically almost 0 capital cost. The aircraft are owned by Amazon, or let's say, they're leased by Amazon and sublet to us at no cost. We provide crew, line maintenance and insurance. So it's great, great flying.

And can you talk about the profitability of the business?

Yes. So the business is a significant contributor to Sun Country. I can't get into the details of the contract. As we've said before, when we signed -- when we re-upped with Amazon in June of '24, the contract changed, there were some rate escalators in there. So by the time we get to sort of '26 steady state when all the aircraft are in, the contribution of the Amazon business and the passenger business are about the same.

Well, it's pretty significant then?

Yes.

And I think previous...

I'm sorry, I don't mean it from an absolute dollar perspective, from a margin perspective.

Got it. And is there protection for potentially a new pilot contracts, which I think becomes amendable next year, is that right?

Yes. So there are -- there's not a cost -- there's no escalators in that relate directly to our cost. But there are annual escalators that kick in every December. So basically, if the pilot costs go up, margins may go down a bit, but then it sort of catches up as the escalators...

Okay. Well, maybe just backing up here more broadly because, again, I think investor appetite for airlines is finally at a level that we haven't seen in a while. How is the industry backdrop playing out on the scheduled passenger side?

Yes. So in our markets, and I think generally, there's been a lot of capacity discipline. If you look at ULCC capacity in our markets in the first quarter, the number of seats is down like 40% to 50%. So there's been a big reduction in our markets in ULCC capacity. Legacy capacity sort of up mid-single digits, but a lot of it's not sort of overlap with us. So the capacity backdrop right now is very favorable. Last year, it wasn't so great. Everybody grew a lot, including us. This year, much more marginal growth, and it looks good going into the second quarter.

Okay. And what can you tell us about -- I think your first quarter revenue guidance was pretty good sequentially. Is that right?

Yes. First quarter is our strongest quarter. We're 100% leisure carrier. A lot of it in the winter is north, south, taking people from cold climates to vacation destinations. And it's our strongest quarter by far. And this will be a strong, strong quarter, put it that way.

Okay. And I guess, bookings are trending in that direction just as you...

Yes. So the first quarter looks good, as I said. Second quarter we have visibility, let's say, into April a little bit, into May at this point. April looks very strong, and that's driven by, I'm assuming strong demand, capacity discipline and the Easter shift, which is a big deal.

Okay. And how much points of revenue does that usually move...

Hard to sort of say, maybe a couple of points or RASM points.

Okay. But this year, because of the ramping up of the Amazon contract, you're actually going to pull pilots out of scheduled...

So if you look at our capacity profile, sort of up mid-single digits year-over-year in Q1; shrinking 7%-ish in Q2; 10%, Q3; and then kind of mid-single-digit shrink in Q4. And the reason for that is all of the block hours we can generate are dedicated to growing the freighter business from 12 aircraft to 20 aircraft. That's going to necessitate a bit of a pull down in the scheduled service business. '26, all the freighters will be in, and then we will resume growing on the passenger side.

Okay. And when you cut capacity, what's the decision...

I mean it's the most marginal flying, right? So I mean it's -- the model -- the Sun Country model is relatively unique in that we very much are focused on flying at peak periods to capture maximum unit revenue. So we look very route by route, very granular. That's how the cutting will take place. There's not strategic markets or things like this. The most marginal routes will be the first ones that go. And the number of destinations we're reducing is actually relatively modest. It's probably going to be more frequency when that comes out.

Okay. Should we be thinking then very margin accretive this year?

Yes, that should be margin accretive this year. Absolutely.

Along with the step-up in Amazon rates and flying, right?

Exactly.

So I guess from a margin profile, though, you guys are near industry-leading. Is that correct?

Since we came out of COVID, we've led the industry in profitability in, I think, '21, '23, last year, [Technical Difficulty] just behind a couple of legacy carriers. But the most profitable low-cost carrier in the industry. And I expect to repeat that as we go into 2025.

And a lot of that just has to do with your ability to really focus on peak flying. Is that right?

The model works in a really integrated way. So on the scheduled service side, the business, as I said, is focused on capturing revenue during peak periods and not flying during periods of lower demand. So as an example, we'll have twice as many ASMs flying in March as we do in September. So the schedule is very, very highly variable. That's linked to our fleet strategy, which is mid-life 737 NGs. So relatively low-cost fleet strategy, we can justify aircraft just with peak flying, we don't need to be flying them in off-peak periods to cover high aircraft fixed costs. So that's 1 aspect of the model. The other aspects of the model are our charter business and our cargo business. The cargo business as I just talked about is 100% under contract, very steady throughout the year. The charter business, about 75% of that business is under long-term contract, also steady. So they kind of offset the peakiness of our scheduled service business. The fact that it is all 737-800s means our pilots move seamlessly between all 3 segments. The -- so we -- the costs are shared across all the segments of the business.

And how is the charter market right now?

The charter market is generally good. In the last few years, we've signed a few pretty significant contracts with MLS and others. There's other opportunities to be had on the charter side that we are actively pursuing. But I would say the charter market is pretty strong right now, pretty strong. One of the things about the charter business for us is we don't compete in a lot of areas that require unique configurations, so unique interior configurations. The interoperability, the interchangeability of the aircraft between scheduled service and charter basically means we have 186-seat config flying in both.

Okay. And there, you're protected on fuel prices, right?

Yes. About a third of our capacity, we are basically hedged against fuel price movements because Amazon pays for their fuel, and the charter contracts have a fixed fuel price. If fuel goes up, we get paid more.

Okay. And obviously, your home base in Minneapolis, you have a lot of overlap with Delta. How is that competitive overlap played out over the last couple of years.

I would say we try to -- I think we serve a different market niche than Delta does. First of all, we operate out of a separate terminal at the MSP airport. Our business is focused on 100% leisure travel during peak periods. We do not pursue business customers. The average Sun Country traveler might travel twice a year. Family [Technical Difficulty] this kind of thing. The bread-and-butter sort of business [Technical Difficulty] is not what we compete in. So from our perspective, I think we coexist fairly well at Minneapolis. Now we have overlap on many different routes, and we're going to try to be the price leader when those overlaps occur.

Okay. And there's been a big push in the industry, and we've had a lot of airline executives here over the last 2 days, talking about premiumization, decommoditizing travel. Is that a trend that you're seeing in your business as well?

So the way the aircraft are configured today is we have a sort of a Southwest like product. We have more seat pitch than the other ULCCs, better quality seats. And then the first 5 rows are extra legroom seats. We've been selling those for 5 or 6 years now. I don't think you're going to see big changes in our product. I think we're very happy with the product as it is. The sort of financial results speak for themselves. We're not going to try and out premium legacy carriers. That's not our niche. We're a leisure carrier, focused on leisure passengers.

Okay. If there's any audience questions, just raise your hand, we'll get you a mic. So as you look into '26, I think you've already -- you have some 737-900s that you purchase, but are on lease with another airline, right? So how does that kind of feather into the fleet?

Yes. We have 7 aircraft right now that are on lease to 2 other carriers, not U.S. carriers. So the way we've sort of tried to set this up is our growth in '25, as I was saying, will be all on the cargo side. In '26 and '27 with all the cargo growth in, we'll be growing the passenger business again. And we're going to grow that with a combination of [Technical Difficulty] utilization on our aircraft. And [Technical Difficulty] these aircraft off of lease, which we already own. So the benefit is, basically, we probably have 3 years of growth built in at no additional CapEx, no additional aircraft.

Right, because you've spent the capital and...

Yes, we own the aircraft at this point.

So what's the right level of maintenance CapEx in the business?

We'll probably spend $90 million-ish this year. Last year, we spent in the $80 million range. A lot of that is spare engines, and then it can spike up if we're buying new airplanes, which again, we're -- don't need to do for a while.

Can we get a microphone up here, please? And maybe while we did it, can we queue up question #4 for the audience, please? In your opinion, which should Sun Country do with excess cash, bolt-on M&A, larger M&A, share repurchases, dividends, debt paydown or internal investment? Thank you, everyone, for participating. All right. John, do you have a question?

As the operations shift more to cargo later this year, is there any opportunity for like better cost efficiencies? Or are you going to see more or less overhead costs? And then I was also thinking with premium pay that you've had to pay on the scheduled passenger for pilots. Is there potential alleviation in that in the back half?

Yes. I mean the -- we already have a cargo business up and flying. So the additional overhead that we need to take on for the additional -- for the other 8 aircraft that are coming is very minimal. I mean, very minimal. So we should get bigger without having to add any fixed cost from that perspective. Sorry, what was the other part?

On like premium pay for pilots...

Yes. So from a premium pay perspective, the pilot situation at the company has gotten much improved, much more stable from what it was, let's say, 2 years ago. Two years ago, we had basically a shortage. So we are having to pay out a lot of premium pay to get guys to pick up hours. That situation has gotten much better. We can basically hire the pilots we need to hire. So the premium pay situation was better last year, and it would be better this year, mainly driven by that.

And then a question around the network in Minneapolis. You've stated JetBlue has largely exited the market. Are you kind of backfilling their schedules? Or with, I guess, continued growth, how much more on peak growth do you see in Minneapolis? Or are you starting to look outside of...

So yes, JetBlue pulled out of the market. We haven't responded directly to that. There is opportunity still to grow peak flying and new destinations out of Minneapolis for us. We are -- we have been growing in other regions like Wisconsin, Milwaukee, Madison, cities like that, that's sort of really fertile ground for us. But the reality is, we're not -- 2026 will be basically, for the most part, adding back flying that we took out in '25 to support cargo growth. So it's really not a real issue for new markets until we get into sort of the '27 time frame. And we still think there's opportunity for Minneapolis flying as well as sort of more focus on some of this upper Midwest stuff. Like right now, in addition to Minneapolis, we also operate a network out of Dallas in the summer. We do a lot of beach traffic, Mexico stuff out of Dallas. So there's going to be opportunities like that around the country as well, but [ Minnea ] Upper Midwest is kind of the company's bread and butter at least for the next several years.

All right. Can we queue up question #5, please? In your opinion, what multiple of 2025 earnings should Sun Country trade.

Hopefully, it's [indiscernible] #6.

There's 1 person in here. Can we go to question #6 please. What do you see as the most significant headwind for Sun Country core growth, margin performance, capital deployment or execution? And Dave, while we await these results, like, I guess, I want to come back to the cost efficiency question. How is that going to play out, especially as you're shrinking the schedule a little bit this summer?

So from a CASM perspective, we've had our costs pretty well in control. So we grew CASM in 2024 over '23, between 2.5% and 3%. This is adjusted CASM ex fuel, which are close to industry leading, I believe. '25 is going to be, as I sort of said before, mid- to high single-digits CASM growth we expect, largely driven by our shrink. So as I said before, we grew in the first quarter, shrinking in 2, 3 and 4. The net of all that is probably down 3% to 5% for the year. That's going to result in sort of these CASM numbers I just talked about, mid- to high single digit.

Okay. But thinking beyond in just '26, you will have an amendable pilot agreement. Is that right?

Our pilot agreement becomes amendable in December of this year. People who know the industry have a sense, I think, of how long it takes to negotiate these things. So there's going to be changes in pilot rates coming down the line. It's probably not something that impacts the company for 24, 36 months, frankly.

Okay. But how do you think about managing through? Because obviously, wages have gone up for pilots, right?

So we had a -- basically, a little bit of history. So the current team sort of showed up in the 2017-2018 time frame, just right around the Apollo acquisition. The company had struggled a lot before that. So the pilots were underpaid because of the smallness of the company, the struggles that the company had. They had a really old contract. So we had a really big increase when we did our new pilot deal at the end of 2021. That increase is not going to repeat. So that was sort of a onetime corrective to get us back into the, let's say, peer set compensation world. We'll see what happens with others and what the world looks like, but I wouldn't expect anything close to that going forward, those kind of increases.

Okay. Got it. And then we only have a couple of minutes left here, but topic in airlines has been M&A. And obviously, Frontiers made it very clear that they want to acquire Spirit. They've gone [Technical Difficulty], I don't know. Just how do you see the landscape playing out [Technical Difficulty] would you guys ever participate...

I mean I think we've talked about this publicly a number of times. I mean, we're pro-M&A. We think there are combinations that make sense. We think there are combinations that make sense with us as a part of them. The uniqueness of our model makes it a little more difficult for us. We got 20 freighters, this kind of thing, which is different than some of the other stuff. But we think that there's combinations with Sun Country that make a lot of sense, and we'll continue to look at things. It's certainly not our base plan. But I do believe that the industry needs to consolidate on the low cost side and participate in that as needs be, but it feels like some combinations are coming relatively soon.

All right. Well, Dave, thank you very much. Great business you guys have. Thank you.

Appreciate it, Brandon.