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

Good afternoon, everyone. Thank you for joining us today. Our next session here at the BofA Industrials Transportation and Airlines Conference is Sun Country. Sun Country is represented here by their CEO, Jude Bricker. Jude, thank you for joining us.

Thanks, Andrew. Good to be here.

I think it's first time at this conference.

It is. Yes.

So look, Sun Country is more than just a passenger airline. You also run a much more, I'll call it, predictable kind of charter and cargo business that I know you want to kind of get into and talk about a little bit more because it's one of your differentiating factors. But I'll start the conversation. And if during the next 30, 35 minutes, if anyone has a question, just raise your hand, and I think people can get a mic over to you. But maybe touching upon starting with the airline, the passenger airline side of everything first. I know you reported just a couple of weeks ago, last week, we had -- Allegiant said that things were improving a little bit of late. I think United had some comments over the weekend as well saying something similar. I guess what are you seeing? Because obviously, from where I sit, the TSA throughput, that is still a little soft or card data is a little soft. So could you corroborate what they're saying? Or what are you seeing in the demand environment?

It's important for some context there that we're shrinking our scheduled service business while we grow our cargo business faster than we can add pilots. So we're taking on a bunch of airplanes that had been operated by Atlas. Those airplanes are going to essentially double our cargo business by the end of the year on a year-over-year basis from a revenue standpoint. And it's just more rapid growth than we can absorb. So as a result, we're going to cut down our sched service temporarily so we can add these cargo airplanes. So that's just context because the yields that I'm seeing are partially due to the reduction in capacity that we ourselves put into our network. So in April, we cut, I don't know, 5% of our ASMs and saw about 3% to 4% uplift in unit revenues, which is I would expect a little bit more also considering the Easter shift with the late Easter relative to last year. May, a little bit better, maybe 5%, 6% unit revenue improvement. So we're on track for some really good results. We guided about a 3% unit revenue 2Q year-on-year improvement. So we're kind of ahead of where we had thought we would be. I think the challenge that the whole industry had is we're kind of reporting close into all this tariff stuff going on. And so everybody is watching bookings. If you're watching bookings right after Liberation Day, you saw a lot of softness. I guarantee every airline was seeing that, and they were kind of like, "I don't know where we're headed here." So for the most part, that recovered pretty quickly. As I mentioned, April and May selling pretty well. We got a lot of close-in demand in the summertime. So it's still too early to call on June and July. But it looks pretty good. I mean our capacity backdrop of the markets that we serve, both us and other airlines, kind of flat to down. We've seen a lot of pullback from our core market, Minneapolis, other than us and Delta. Southwest is down substantially. The ULCC's Spirit and Frontier pulled back dramatically. Allegiant just extended their schedule. They're not even including Minneapolis in it. So it just looks really positive. I think we're going to see unit revenues continue to perform really well for the rest of the year and grow.

Got it. Obviously, your key source market is Minneapolis. Can you maybe talk a little bit about who that core customer is within the market? And has that changed since over the last few years as Sun Country has grown as well? And how do you expect that customer to change, if at all?

Right. So the tagline is everybody that pays with their own money to fly Sun Country. We're going to fly where you want to go when you want to get there. And that means the network has to be dramatically different seasonally. So think about our winter customer is flying north-south of the warm destinations, Minnesota, obviously, cold. And we've been doing it for 40 years. That's kind of the core of the Sun Country model and hasn't changed much in a really long time. What's changed is that the summer now is a really viable part of our network, but it's to different places. Think of it mostly as big city connectivity to the Twin Cities. We fly a little bit of transcon connectivity over MSP Airport. We have a big summer origination market out of major Texas markets like Central Texas out of San Antonio, we chose over Austin, DFW, Houston. So it's a totally different network each and every day. Our relationship with our consumer in the summertime is essentially on price. We have a lot of single-use customers and they choose us based on value, but there's just not enough seats in the marketplace over the summer season from Memorial Day to Labor Day to satiate demand, fares are higher. And so even though we're discounting relative to an incumbent, we're still a viable competitor in the market. In the wintertime, it's different. We have pricing power. We have brand presence. We have monopoly markets. And so that's why we do mid-18% margin in the first quarter is that we have this really stable, large source of demand in the Twin Cities for people going to sunny destinations, really viable business. And then in the summertime, and when I got to the business, I was like, all right, we got a strategic weakness about how do we make the peaks bigger without getting worse in the off-peak, carrying the pilots and planes, et cetera. And that's where cargo came in. And so today, think about the business as kind of loading in cargo for future sched service growth. The margins are in sched service, but we need the right balance, 2/3, 1/3, whatever it is, to kind of keep those troughs cash positive basically, profitable.

So just on your core consumer, do you think your consumer skews middle income, upper like kind of, I don't know, in and around that $100,000 per year wage rate or just...

Yes. I'd imagine we're like 10% over median household, which is probably $74,000 in Minnesota. I mean we have a fairly diverse customer segment. So we serve expensive markets like Grand Cayman, Aruba, St. Thomas, St. Martin. It's a $10,000, $20,000 family vacation to these destinations. And we also serve Myrtle Beach. Nothing against Myrtle, but it's certainly a value, family oriented.

Different value property.

Yes, yes, yes. So I think we have kind of across the spectrum. And like I said, I want to be known for value, convenience, reliable operations. And the airplanes are designed and the product is designed to be a little bit better than kind of Southwest. We have really nice seating. It's 3x3 seating because it's 737, but we have a little bit better pitch than any ULCC. We give away nonalcoholic beverages. We have free onboard entertainment. And the reason for a lot of that is that it's a long stage length market. We're in the middle of the upper Midwest. if you're going to go to the coast, it's going to be a 3-hour flight. So you got to have a little bit better product, and I think it resonates pretty well with the consumer.

We've always been hearing a lot from the network carriers about the strength of premium revenues and how customers continue to want more of a decommoditized experience. I guess do you have a good way to frame the market in terms of the travelers that just want kind of just a very simple kind of main cabin type experience and kind of don't care about the higher end? Just I know you compete a lot against Delta in Indianapolis, so you might have maybe a little bit more unique view on that.

Well, Delta has a great product. And so I think that holds us to a higher standard. The Minnesota travelers probably has flown Delta and has a high expectation for both operational performance and product. I mean we have 20% of our seats as premium economy seats. The price point of premium economy and basic economy have widened, but not substantially enough to justify like a cabin reconfig with more premium than has existed before COVID. So it's been relatively modest. I think that a lot of what the -- I think there's like kernels of truth in everything that you're hearing from the network carriers. There's demographics with the boomers traveling that are more willing to pay for premium. There's probably a lot to do with their loyalty program and redemptions being more skewed towards premium. So I think -- but I think the future looks a lot like the past, and there's going to be kind of a sizable demand for the basic. People just want to get there, price is the key component of their travel decision. And then we have markets where premium economy yields 40%, 50% higher. But for short-haul flying, it's just not that meaningful. And if you're flying from Minneapolis to Chicago, one of our shortest stages, premium economy has almost no premium. And so I think there's a lot more color to it. We're not adding a first class. We don't have a business customer. A lot of first-class customers don't pay with their own money. They're either travel redemptions or corporate customers. And that's just not a dynamic. We don't really want to be threatening to Delta for corporate contracts. So I think we've got the right mix. It's working well for us. We have the leading margins in the industry. Yes.

It seems pretty simple.

Yes. I mean the cabin lasts about 7 years. It's viable for us to say, okay, in 2018, we went through a big -- we went through private equity sponsorship. We changed the airline dramatically, took out first class at that time. The cabins that we have are basically what we put in, in 2018. We're about 7 years in. In the next couple of years, we're probably going to need to make a decision about a major change because we need to replace the seats. We might want to replace the fleet. Certainly, IFE has made -- in-flight entertainment has gone a long way. There's a lot of buzz about Starlink, low-orbit satellite connectivity, which takes away the latency that had existed with what was in place 10 years ago. So right now, we're kind of waiting and seeing. And I think we've got the right product for the market today, but yes.

You certainly didn't rush into any changes like some other airlines.

Yes. I don't think we need to do anything. I mean we're making good money. So I think if you're not, then you're flailing around trying to find something that works, I get it. But no, we're not in that place.

Yes. Just curious, if cabins typically last, call it, 7 to 9 years, what does it cost to completely redo a cabin and...

It depends on the cabin, of course. But if all you do...

If you just wanted to freshen your current cabin.

Yes. So new seats, carpet, that kind of stuff would be around $600,000. If you're going to put seatback devices, that's about $1,000 a seat. So that another $200,000, $250,000. That's for a pretty basic product. And then in-flight connectivity would be another $1 million if you're going to have a satellite antenna and that kind of stuff. So you could get up to $2 million for a narrow-body all the way down to like if I'm putting, I don't know, the old -- the Acro seats, the Frontier Spirit, and Allegiant fly, I can probably get it down for $400,000.

Okay. Very interesting. So you say you're cutting capacity, cutting seems like kind of low to mid-single digits. Where are you -- like what kind of flying are you pulling right now?

Mostly, it's off-peak stuff, as you'd imagine. So consistent with what you're hearing, Tuesdays, Wednesdays, Saturdays are a little weaker. Shoulder months like May coming down a little bit more than June and July. The big thing is we don't have any bad markets. So like you haven't seen a lot of markets come off our network. We do have some...

How do you define a bad market?

It loses money.

Just loses money. Got it.

That's not fair. I would define a bad market as a market that doesn't perform to the opportunity. There's something better to be doing with the plane and pilots at that moment in time. So a market that in September is a little bit better than breakeven might stay in the schedule. But a market -- in March, you got to be making 35% contribution or you're out. And so it's really about opportunity cost at that moment in time. Surprisingly, some of the stuff that was -- not perhaps surprisingly; last summer, the Midwest to Minneapolis wasn't very good. This year, it looks really good. And that's because the OA capacity kind of rationalized. Last summer, we had a really great summer in Texas to the Mexican Caribbean markets. That looks really good this year again. California is a little weak out of the Midwest, and I can't explain it based on the capacity out there. But the Northeast looks really, really good, and Boston in particular. So it's kind of mixed. And I look at the schedule as a working document. So we put a flight in the schedule. We monitor the sales on that flight like every airline, but we're constantly forecasting the results of that flight. And if it becomes clear that, that flight is not going to cover some hurdle, it's cut. Same thing is if a market exceeds its expectation, we can add.

How long do you give that?

Well, there's practical constraints related to the operation. At the beginning of every month, I bid subsequent month out to the pilots. Once it's bid out, it becomes paid. So it's a pay guarantee. So by the -- basically, by Friday, I had to have June kind of set in stone. But we usually load a schedule 330 days out. So there's a lot of period where you can analyze the schedule that you're selling and continue to optimize it.

Yes. Look, you're not the only one to call out pulling off peak, right?

Yes.

I think we've heard that from everybody else. And it is something like -- I don't know, I think -- I even heard pre-pandemic that like, obviously, peak is always better than off-peak. What needs to -- like can the industry ever solve that peak, off-peak problem? Or is it just not realistic enough to have fleets of this size not operating 7 days a week?

I think that people will always want to travel when they travel. Coming out of COVID, this was a popular input. It's like, "oh, everybody is going to be work from home. There's no peaks anywhere." And instead, like the opposite has happened. Like now vacations become more valuable. Time off becomes more valuable. Everyone went back to work. Kid went back to school. Weekends are important, holidays are important, et cetera. March is important for me. So it's kind of like back to normal with regard to peak and off-peak. So the demand has predictive variable nature. And so yes, I think it's always going to be the case. And I think the big thing now versus previous kind of if you look at margin reversion from the ULCC space, you have the maturity of all the network effects of these mergers from the big 4. So loyalty program is a lot more valuable. And then you have the costs rising from the ULCC, so that they're no longer able to stimulate in the off-peak to the same degree that they did in 2019. And then I think basic economy is a pretty effective tool that the network carriers have to put seats in the market when there's insufficient demand and compete on price and then put those seats -- pull those seats out of the market when there's surplus demand and so they can yield up. So I think the network carriers have, for the most part, been able to manage it a lot better to the detriment of high utilization ULCCs.

Got it. Last question for now on the passenger side. I definitely have some more to come back to. But with capacity in mind, how do you view kind of the medium- to long-term growth CAGR opportunity for Sun Country?

Well, I mean, we're an outperformer. We had the highest pretax margin in '23. We're kind of tied with Delta last year. So a company that's outperforming and differentiated and also difficult to replicate because we have a cargo interaction with sched service, I think we can grow, I don't know, 5 points higher than GDP a year. So let's call it, high single digits, low double digits, kind of as long as we can continue to buy airplanes at suitable prices. So I don't think there's a demand. It's a really massive TAM because every major market has these demand variabilities on leisure. And I think if we could go in into these major markets and operate. So we're not competing against leisure, which is monopolist small market origination. We're not competing with Spirit and Frontier for off-peak demand when there's not any pricing power. I think we have a huge opportunity. I think we can continue to grow much faster than GDP. What I'd say, though, is we need the balance that we have. We can't let sched service get too out in front of our fixed fee flying, and we can't let fixed fee flying get too far out ahead of our sched service growth. So the proportionality of our segments is important to us, and it needs to be kind of fixed fee charter flying, kind of contracted flying is the same to us as cargo. And that in aggregate needs to be between, I don't know, 20% and 40% of our flying in order for us to be able to operate in the kind of peaks that we do in sched service. So I think that would be a potential constraint on the growth of the business.

Interesting. Okay. Just going to lead me into my next question now maybe touching upon cargo and charter a little bit, right? I know on your earnings call when you reported in first quarter, your cargo revenue per block hour was up 20%. Can you maybe talk to, one, how you kind of schedule or how the schedule needs to change in order to accommodate cargo and the charter business? And then maybe just talk to the strength that you're seeing on the cargo side. Is that just the rate reset? Is that true demand, a combination of both? Just I'm curious your thoughts on there.

Yes. So from a -- looking down in the business, we're sucking in pilots as fast as we can. And so that's a constraint on growth. So we're growing our capacity -- our pilot capacity 10%, a year. And I can make it faster, but that requires infrastructure investment, maybe contract changes with the pilot union. So we're in like a sustainable growth profile. And all that's happening is we're getting more cargo than we can grow the pilot group. So we're subsidizing cargo growth with cutbacks in other lines of our business. And it will rightsize because we're going to continue to grow 10% a year. And so 2027, we'll have all 70 of our aircraft in service, we'll be 30% bigger than we are today, and everything will be back to the right size. The unit revenue improvement in cargo is contractual. So that we signed a deal with Amazon last year that took the Atlas airplanes and brought them over to our certificate as part of that. They increased their rates with us. And that's in perpetuity. I mean that's not going anywhere. It's pass-through economics. So they buy the gas, they pay for handling. They worry about the revenue that the plane generates from the consumer, and they pay us a tolling arrangement. And I think the right way to look at our business is that arrangement along with our track charter businesses, which are long-term pass-through economic businesses in the same way like SkyWest has...

I was going to say it's like a regional carrier.

Yes, it's like a regional. So those proceeds kind of service the fixed costs of the business and allows scheduled service to be completely responsive to predictable variations in demand, so seasonality, off-peak peaks and stuff like that, and also disruptions like COVID. I mean we made -- we had a positive EBITDAR in 2020. I don't know if any airline in the world can say that.

And that's when cargo was smaller, right?

Yes. We just started cargo at the beginning of that year. So I think it's a very sustainable business. We're being very careful about growth. We got to get the planes at the right valuation to be able to operate at low utilization. That's a challenge in this market. So -- and the other thing is cargo shows up -- you talked to Amazon about incremental growth, it's a different conversation than incremental growth to me.

For you. Yes.

So it comes in chunks, and we're digesting a chunk now.

Right now.

Yes.

Yes. Got it. I guess I'm a little less familiar with charter operations. Like of your charter business, how much of that is kind of really under contract for the foreseeable future, right? Like so you fly college football teams or whatnot. How far out do they book? How much visibility do you have there?

Yes. So there's kind of shades of that. So we're in a long-term contract with Major League Soccer. That's contracted flying. We have 5 airplanes with casinos, that's contracted flying. And then we have a VIP airplane that shuttles people, rich people. It's like the Gulf Stream minus. You're not quite up there, but you have a second home on Kona, so you're going to go back and forth FBO-FBO. So we got that going. So that's 6 airplanes plus MLS, I consider that under long-term contract. That's about half of our charter business. The other half is in shades of commitment. And what I mean by is the government, we're in the craft program. We fly the GITMO charter, happens every couple of times a week. These are flying -- I want to be clear. We're flying troops. We're flying servicemen.

Not the teen-ies.

Yes. We're flying servicemen back and forth. And so that shows up pretty consistently, but a lot of the military flying is 2 to 3 weeks out. And then you brought up college football. We don't have anything contracted in college football. But what happens is we fly about 23 teams every year. So these are long-term relationships that show up every year, but it's not contracted. So it's kind of shades of predictability. What we do in charter that I think is unique in the world maybe is that we schedule in predictions of charter volume. So think about Vegas. Thursday inbound great, Sunday return, great. A lot of the rest of the stuff is pretty terrible, particularly if you have to schedule a round trip. So if you have to schedule a Sunday round trip, you fly into Vegas, planes empty, fly out of Vegas -- a little bit of hyperbole -- planes full of high-paying customers. Everyone wants to go on Sunday afternoon. So instead of doing that, what we do very often, using Vegas as an example, is schedule the airplane in on the Thursday out on a Sunday. It's scheduled to sit on the ground for 48, 72 hours. We know later on there's going to be a charter opportunity on the West Coast for that airplane and crew. But when we built the schedule 300 days out, we don't know what it's going to be. So that allows us to bid competitively in the charter space and allows us to fly strength when there's strength in demand for sched service. I think it's pretty unique. And so when we think about Major League Soccer, the reason that I think that contract is going to be with us forever is that we build our whole network around Major League Soccer movements. So we'll schedule into Kansas City, a one-way flight, and that allows that airplane to be positioned to move the Kansas City team to Salt Lake and then we'll schedule back and then we'll unwind it on the other way. And so we don't have to bill them for ferry flights, which is pretty unique. If you're a pure charter carrier, you...

You get the ferry income, right?

You have to. If you're a pure sched carrier, mostly you're bidding out charter. Think about it as an offload of surplus capacity, but the plane is never where you need it to be, so you have to charge the customer for ferrying. And so I think our charter business is going to continue to grow. It's high margin, reliable. It's not going to produce the kind of growth numbers that we're going to see in charter and cargo this year nor in sched service in '26.

Got it. What do you think is the investors miss when they think about your cargo and charter business?

Well, I mean, I think the #1 thing is how much better we are on the sched service side because of cargo. So the way we think about scheduled service is, let's start with a blank slate. Nothing scheduled, do the best thing an airplane can be done on that moment in time and keep doing things until we run out of things to do and the rest of the fleet is grounded or we run out of airplanes and the fleet is fully allocated. That's how we schedule the airline. Most airlines build a schedule, optimize it for cost, crew, gates, all that stuff, it's input. It's very complicated. And then they replicate that 365 days and then they make tweaks around that for holidays or whatever. That's mostly how airlines schedule their business. I think that's a dramatic departure and kind of what gives us, I think, a differentiated product is the way we think about capacity and sched service. And to your question about what people miss about charter and cargo is that we can do that because we have things to do if we don't have any sched service flights. It's not -- I'm never going to go into a scheduling department and be like, "hey, there's 25 airplanes on tarmac, what are you all doing?" That never happens. Instead, I'd be -- after the month closed, I'd be like, "hey, that flight didn't make its contribution, didn't cover hurdle, why was it in the schedule?" There are only a couple of responses. Number one, it was the beginning of the season, we had to fly empty one way. Number two, it's a new market, and we're working on improve it. And number three, there's some rational assumption. I thought fuel was going to be different than what it was or whatever. Like there needs to be some justification for that to be in there. And mostly airline guys look at route prop and stuff like that on averages. And I think that's the wrong way to do it. We're very micro in how we think about it.

Got it. So we got about 6 minutes left. There's one or two other questions I want to get in here. And the first one is just on comments you made on your earnings call just around maybe kind of M&A across the airline sector. I said my question, I guess, one, how does it make sense, in what form? And would Sun Country be a willing participant in that?

So I think I'll do it in the LIFO method, right? So like your last question was, is Sun Country interested? Absolutely. I think the industry uniformly benefits from consolidation because it rationalizes capacity. But we're small, we're independent, we're weird, so we're not a natural fit. There's no puzzle piece that goes naturally anywhere. And so I don't spend a lot of time worrying about it. But my comments were basic. There's some unsustainable -- like so Spirit and Frontier haven't made operating cash -- positive operating cash flow since COVID. JetBlue is in that camp too. Allegiant is working on trying to kind of go back into being an airline and down into their core business. There's 2 start-ups in the space that haven't made money yet. And so it's irrational. It's unsustainable. Airline equity has gotten to be really, really expensive. So yes, I mean, I think there needs to be some action. I'm kind of disappointed with the Spirit bankruptcy and what it produced. So I mean, I think, seats need to come out of the market or costs need to come down for low-cost carriers. And we're going to be ready to take advantage of any opportunities that are out there. But I'm not running around placing bids on anybody.

So I guess my last question with a couple of minutes left is so bigger picture, right? Clearly, a structural shift going on out there in the market. You spoke well about the lower end. Obviously, your margins are up there with the Deltas and Uniteds of the world. So we're seeing a big dichotomy in the space. I guess when you think -- when you're doing your strategic plan 5, 10 years down the road, how do you think Sun Country fits into this broader industry backdrop going forward?

Yes. I mean, to me, we're the leisure carrier that services capacity out of big markets. Right now, we're out of Minneapolis. I think in the future, we want to be -- we have a seasonal operation out of Dallas that's real successful, out of Central Texas, out of Milwaukee. We originate traffic out of the Upper Midwest from small origination markets like Eau Claire, Green Bay, Madison, Wisconsin. So I think there's a lot of opportunity, but it's kind of a crowded space. Planes have gotten pretty expensive. Crews are a lot more expensive than they used to be. And I think that our right thing to do is kind of get a strong balance sheet made stronger, continue to kind of absorb these opportunities in cargo so that we're kind of spring loaded for growth when the market changes. I mean on the positive side -- like load factors are pretty high. There's a lot of demand for travel. I think as a secular product, I think it's going to continue to do well. People are going to want experiences. We talk a lot about consumers shifting from goods to experiences and I don't know, GLP-1 drugs making people more comfortable moving around. I don't know. I think there's a lot of tailwinds in demand. So yes, I mean, I just think we need a little bit more rationalization in the low-cost base.

In capacity.

Yes.

You mentioned other markets outside of Minneapolis. What's like -- if you were to expand or grow more meaningfully in another market, what would the characteristics of that market be?

So the very best thing would be counter seasonal to Minneapolis. I struggle to think of anything better to do as a leisure carrier than fly Minneapolis originating service from Thanksgiving to Easter. We reported first quarter 18.5% operating margin. That was the same as we had the year prior, down from the year prior before that. So we make really good margins during that time of the season. So to me, the best opportunity is summer originating markets for leisure customers. Price sensitive is leisure. And fortunately, most of the country is that way. All of the Northeast has a summer peak. Most of the South has a summer peak. So Minneapolis is a bit of an outlier, and that makes counter seasonal more easy to find. But right now, things are pretty crowded out there. So we're not out there chasing low-yield traffic. But I think Dallas will continue to expand for us. I talk a lot about Texas. But sort of every major market, say, maybe Chicago, has a nice winter. But like Upper Midwest has the characteristics of the kind of market that we'd be successful in and will be complementary to our Minneapolis business.

Great. Just a few seconds left. So maybe we'll leave it there. Jude, thank you.

All right, Andrew, good to see you.

Pleasure.

Yes. Thanks, guys.