Sun Country Airlines Holdings, LLC Q4 FY2022 Earnings Call

Welcome to the Sun Country Airlines Fourth Quarter and Full Year 2022 Earnings Call. My name is Chris, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. And 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, and Dave Davis, President and Chief Financial Officer, along with a group of others who will help answer questions. Before we begin, I'd 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 based on management's current beliefs, expectations, and assumptions, which 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 earnings release and our most recent SEC filings. We assume no obligation to update any forward-looking statements. You can find our fourth quarter and full-year earnings press release on the Investor Relations portion of our website at ir.suncountry.com. With that said, I'd like to now turn the call over to Jude.

Thanks, Chris. Good morning to everybody. To review, our multi-segment business is unique in the airline industry. Due to the predictability of our charter and cargo businesses, we were able to deliver the most flexible scheduled service capacity in the industry. The combination of our schedule, flexibility, and low-cost model allows us to respond to both predictable leisure demand fluctuations and exogenous industry shocks. We believe due to these structural advantages, we'll be able to reliably deliver industry-leading profitability throughout all cycles. The execution of our multi-segment business is critical for delivering industry-leading operational performance. I'm especially proud that in 2022, Sun Country delivered the industry's best completion factor. During the challenging December period, we achieved a 99.6 completion factor, also the best in the industry. I'm so proud of our whole team that continues to come through for our customers every day. We continue to see strong demand for all segments of our business. In scheduled service, currently selling through August, we're seeing consistently strong yields even compared to an already strong 2022. The first quarter notably shows year-over-year TRASM improvement implicit in our guidance, mostly due to a strong recovery in international demand as compared to the Omicron-impacted first quarter of 2022. This outperformance is overcoming West Florida demand, which is still recovering from Hurricane Ian. All indications are that unit revenues will continue to remain strong through the summer, including observable bookings, overall industry capacity across our network, loyalty spend, contracted distribution agreements, and local economy metrics. In scheduled service, through the next year, we expect to continue to build out our MSP operation to its natural share. To that end, we've decided to postpone the restart of our summer Hawaiian operations until 2024. Keep in mind that the first quarter is typically our strongest of the year on constant demand and normalized demand. I expect charters to show significant growth in 2023. We're primarily focused on long-term contracted charter revenue. We've expanded our casino operation to five aircraft and added a second aircraft to our VIP operation. I expect to have eight aircraft committed to contracted charter flying by the end of 2023. Counting our 12 cargo aircraft, that brings our contracted fleet to 20 aircraft of the 55 we have in service. All these aircraft operate at consistent operational levels with pass-through economics. This operating base allows us maximum flexibility with our scheduled business. I anticipate our sports business will grow this year as well, concentrating on collegiate sports and Major League Soccer. Charter demand remains strong, and we believe it's generally underserved by the industry. Our cargo business will improve this year due to contracted escalation, but we expect volumes to remain consistent year-over-year as we focus on building out our scheduled and charter businesses. On the fleet, we'll continue to be opportunistic buyers. I expect most of our 2023 growth to come through increased utilization, which remains well below 2019 levels. This will allow us to deploy capital for debt repayments through amortization, consider share buybacks, and some prudent infrastructure investments such as our new training centers that opened in Q4, along with technology to support our operations. I'm confident that we will continue to find the growth aircraft we need as we need them. And with that, I'll turn it over to Dave.

Thanks, Jude. We're pleased to report strong Q4 results, which I'll detail in a minute, and came in near the upper end of our guidance range for both revenue and operating margin. Adjusted pretax income for the quarter was $10.3 million, a 39% improvement over Q4 of 2021, despite an increase in fuel prices of nearly 44% and the impact of the new pilot agreement that we signed near the end of 2021. Although we are now comparing our results to the previous year, it's important to note that our Q4 adjusted pretax income is nearly 26% higher than it was in Q4 of 2019. Additionally, we grew Q4 2022 year-over-year capacity on both a system block hour and ASM basis by 10% and 14%, respectively. Q4 system block hours were 37% higher than they were in Q4 of 2019. Let me start with a discussion of revenue and capacity. As Jude noted, the revenue environment remains very strong. Q4 of 2022's total operating revenue of $227.2 million was 31.6% higher than the year-ago quarter. The scheduled service business is particularly strong as TRASM grew 27% versus last year and an almost 14% growth in scheduled service ASMs. Ticket plus ancillary revenue grew 45% year-over-year as we saw an increase in total fare to $177.36, combined with an increase in load factor from 76.6% last year to 84.4% in Q4 of 2022. This strengthened unit revenue shows no signs of abating as we move into the first quarter. The story is the same for the full-year 2022 with scheduled service TRASM growing almost 37% on an increase in scheduled ASMs of 16%. Both total fare of $175.29 and load factor of 83.5% were the highest full-year results since 2018 when we began our conversion to a single-class configuration. We finished 2022 with full-year revenue of $894.4 million, a 44% increase over 2021 and a record for Sun Country. Charter revenue grew in the fourth quarter by 11% as we saw another quarter of strong growth in flying under long-term contracts, referred to as program charter, and steady improvement in our ad hoc business. Ad hoc charter revenue doubled versus Q3 of 2022 and is showing steady progress as we continue to add pilots to pursue these opportunities. We've made a concerted effort to grow the amount of our charter business under long-term contracts, and we've been very successful so far. For the full year, program charter revenue was $121.7 million, nearly 2.5 times higher than it was in 2021, and we feel there remains room to grow. In the fourth quarter, cargo revenue grew 5% on a small decline in capacity. For the full year, cargo revenue declined 1% on a 4% decrease in cargo block hours. During the first half of the year, we had numerous Amazon aircraft in heavy maintenance, which drove the block hour decrease. Our cargo flying remains a consistent source of revenue in all environments, and we do not expect this to change in the future. Let me turn now to costs. Our fourth quarter adjusted CASM increased 7% versus last year. For the full year, adjusted CASM increased 9% year-over-year. Similar to what we have been saying all year, the main drivers of this cost increase have been twofold: first, we have been smaller than we had initially planned to be due to labor and aircraft constraints; second, 2022 results reflect the cost of the new pilot agreement we signed at the end of 2021. This is an important point, as the results of many of our competitors have yet to fully incorporate the cost of recently completed or upcoming new pilot contracts. Two additional aircraft are expected to enter service in Q1 of 2023. As we grow into our expanded fleet throughout 2023, we expect to see a deceleration in unit cost increases. Let me say a few words now about our strong balance sheet. We finished 2022 with $289.4 million in total liquidity, including $264.7 million in unrestricted cash and short-term investments. Our year-end net debt to adjusted EBITDA was 2.7. During January of 2023, we completed the $25 million ASR portion of our share buyback program, repurchasing approximately 1.4 million shares at an average price of $18.23. We still have $25 million in Board-approved share repurchase authority and will execute any buybacks under the program opportunistically, considering the liquidity needs of the business. Let me switch now to Q1 2023 guidance. As I said previously, we're seeing very strong demand, with approximately 80% of our planned Q1 passenger revenue already booked, and we expect the strength to continue throughout the quarter. Total Q1 2023 revenue is expected to be between $280 million and $290 million, which would be 24% to 28% higher than Q1 of 2022. We expect total block hour growth of 3.5% to 6.5%. We're expecting an operating margin of between 15% and 20%, assuming a fuel price of $3.58 per gallon. Just a quick reminder: Q1 is historically our strongest quarter of the year, and we expect to see seasonal trends similar to previous years. The fundamentals of our unique diversified business remain strong, and our model is highly resilient to changes in macroeconomic conditions. Our focus remains on profitable growth. With that, I'll open it for questions.

Operator Instructions. Our first question will come from Ravi Shanker of Morgan Stanley.

Great to hear the strong commentary for Q1. If you can just give us a little more detail there. How far out the booking curve can you see? Can you see past spring break, maybe into early summer as well? Does it feel like even the tail end of that booking curve kind of continues to remain strong? I'm just trying to get a better sense of what the rest of the year might look like.

The main thing that's impacting the first quarter relative to the first quarter of last year is the recovery in international demand. We have a sizable international network, traditionally, during the first quarter. Last year was affected heavily by Omicron. So we're seeing strong demand across the Caribbean, Mexican markets, and Central American markets, which seems unprecedented in my experience looking at traffic down there. We have really good insight. As Dave mentioned, we're over 80% sold for the first quarter, so there's not a lot of variance there. Most of the variance in our first quarter revenue will come from how much charters we're able to sell into the March period. Looking past the first quarter, April is pretty well booked at this point, and it continues the same trend of fairly dramatic year-over-year revenue improvements. For the summer, we have a little less insight just because summer relative to the first quarter tends to book more closely in. We shift our network to more domestic markets and shorter haul markets, but those also tend to book more closely. However, if we're only looking at unit revenue and fares and ancillary production for the bookings that we can see, which for the summer period is well below 20% of our volume, it looks very strong. I don't see any indication of weakness across the network. I was concerned about Ian's impact because Fort Myers is a big part of our network in March in particular, and that area of the country is mostly recovered. It's still lagging behind the strength in other areas, but there's really no weakness that I can find anywhere across our scheduled service network.

That's a pretty definitive statement. Maybe as a follow-up to that, it kind of sounds like the biggest impediment to growing into that strength is going to be capacity. Can you just comment on what the pilot availability situation is like? And what do you expect in terms of any headwinds there kind of easing in the next 12 months?

Our pilot situation continues to improve. As we've detailed and talked through a number of times, we've had some particular issues in our training pipeline. We continue to have no issues with recruiting pilots to come to the company. So that continues to hold. We're making steady progress, with identifiable improvement in pilots going to the line here, especially over the last two or three months. We expect that positive momentum to continue in the back half of the year. I think I mentioned 3.5% to 6.5% block hour growth for the first quarter. We're looking at block hour growth for the year of around 10%. So we'll be accelerating as we move into the summer months and then into the back half of the year.

Which is particularly positive because we'll be producing double-digit growth rates by June, allowing us to align with the peak opportunities.

Our next question will come from the line of Duane Pfennigwerth of Evercore.

Just to follow up on the last question. And I know we've had an interesting couple of years, to say the least. And prior to that, you had significantly restructured this business. But that 80% booking for Q1, do you have any feel for how that compares to kind of normal, if there is such a thing as normal?

Just on an estimation of about 5 points relative to history. We're booking ahead, and a lot of that is just us aligning our algorithms to the demand environment. We need to load higher fares from the beginning. Recall that pricing is a heuristic algorithm. Bookings determine fares, and a lot of that depends on our expectation going into the selling period, and we are aligning to the new environment. So, we're probably ahead by about 5 points.

On CapEx, can you just remind us how you're thinking about 2023 and 2024 maybe versus the year just ended? Where do those plans stand today? And are you seeing any signs that the used 737 market is loosening up as MAX deliveries finally take the appropriate pace here?

Without going into precise numbers, let me give you some color on CapEx. We added between seven and eight aircraft last year, or I should say in 2022. This year, we are not going to add as many planes. Jude mentioned the fact that we're going to achieve growth mostly through utilization, but I would expect us to add probably one or two aircraft into the fleet this year. So that CapEx will be down significantly. We're already lining up deliveries right now for 2024 and even into 2025. So we expect to resume growth in 2024 with probably seven to nine aircraft in the same for 2025. So we're going to take a little bit of a pause here, which will bring CapEx down in 2023.

On the market, I'm pretty comfortable not being a buyer at the moment. The opposite has happened, Duane. It's actually a pretty strong market for 737-800 values, as airlines across the world extend leases to accommodate delays in their MAX order stream. There's also a broad rebound in demand across the globe. We're still seeing some spot bankruptcies like Flyr in Norway last week or this week. But these planes are absorbed really quickly. So I'm not expecting a lot of price relief, but I'm confident we'll get the planes we need.

Our next question will come from Catherine O'Brien of Goldman Sachs.

I know unit costs have been lumpy. But if we just solved for unit costs in Q1 based on revenue and operating margin, and maybe taking scheduled data for ASM, we get to CASMx growth in the high teens year-over-year. I guess, first, correct me if I'm wrong. But you alluded to a lot more block hours coming online. You're doing that via higher utilization, which I'm guessing is pretty accretive on the CASMx side. I don't know if there are maybe some efficiencies we're getting as we move through the pilot contract. But it would be helpful if you could discuss the level of deceleration on CASMx we should expect from that high teens in the first quarter.

First of all, I'm not sure what the math is there; we can go through it. But that number seems too high. It's not going to be sort of close to the high teens from a CASM basis for the first quarter. I would expect probably a number in the high single digits, very low double digits. As we continue growing here through the first quarter and into the back half of the year, that should moderate significantly. So I talked a bit about CASM year-over-year; we should see any increases we see in 2023 will be significantly lower than what we saw from 2021 to 2022.

One other bit of color is to recall that we did our pilot contract a year ago, and the rest of the industry is rolling through pilot agreements now. So, our cost trends will look really good relative to the industry based on that fact.

Yes, for sure. Maybe just as my follow-up, we continue to see really strong growth on the ancillary side for you. Can you walk us through where the future opportunities lie there? Is that going to be optimizing for yields? Are there any step-function changes, kind of like the offering?

First of all, I would continue to guide you to look at total revenue per passenger. Most ancillary initiatives that increase ancillary unit revenues have an effect on the airfare but increased total revenue per passenger. So, just always keep looking at it like that, particularly bag fees and seat assignment revenue and convenience fees that most airlines are emphasizing right now. What we're focused on, in contrast, is on new products. We launched our bundle solution in the back half of last year, which is performing as expected. We're also, like most airlines, getting a lot of uplift through our loyalty program, which is setting records in every quarter. In the last quarter, that was consistent with that. What's exciting for me in particular is our third party products, where we sell hotels, cars, and travel insurance to our customers. That is purely accretive. Every bit of revenue that's incremental doesn't affect the airfare for those products. We're really excited to see that. On a unit basis, those are increasing by triple digits as we roll out our car solution for the first time, which is really exciting. Therefore, we're going to continue to have a tailwind on unit ancillary revenues, and for us, in particular, I think that's going to drive continued momentum on total revenue per passenger because of the kind of products that we're seeing growth in.

Our next question will come from Helane Becker of Cowen.

On CapEx, what's maintenance CapEx?

You mean like a total absolute dollar amount of maintenance CapEx?

Yeah.

Probably for the year, depending on exactly what we call maintenance CapEx, we include some of our engine purchases in there, probably on the order of $40 million to $50 million.

And that'll be financed through cash, I guess?

That would be financed through cash, yes.

Just my other question, as you think about aircraft, are you just looking at those 800 NGs or do 737-700s make any sense for you? What's like your optimal size that you would be looking for?

We think that the 900 would work as well, so both 800s and 900s.

Our next question will come from Michael Linenberg of Deutsche Bank.

Good numbers and outlook. Just on the aircraft, I want to clarify. Jude, I thought you said you're taking two airplanes in the March quarter. And then Dave said we'll be taking one to two this year. Is that one to two that are incremental to the two because maybe those two showed up last year and are being put into service? I want clarification around that.

Yeah, it's what you just said. So the two that are coming in in the first quarter were purchased last year and are going through induction. They'll be entering service. The one to two that I mentioned are incremental to those two.

These airplanes, they're all being cash financed or debt financed, right? You've moved away from leases, right?

Yeah. We haven't done any operating leases, and we don't intend to do any operating leases. It will be either debt financing, cash payments for them, or entering into finance leases, which gives us basically a purchase option. That's how we finance all of them.

Just from a modeling perspective, you're down to just over $1 million of rentals. Does that go to zero sometime this year? Or is it next year? Or is there always going to be a little residual there?

We have a couple more aircraft that are on operating leases. I think probably 2026?

2024.

2024 for both of them, yes. After that, our rentals will go to zero.

There might be some engine leases from time to time.

A few miscellaneous things like that, but that line should drive to zero.

Lastly, Jude, you have made some interesting comments about how things have shifted and changed through COVID. A few comments months ago, about how demand was shifting through the week. Was it less business travel or more leisure? You made a comment about the fact that the fares were so high during peak periods that it was pushing more demand into Tuesday and Wednesday and helping sort of the volatility on demand and pricing through the week. Any additional thoughts around that? It’s always interesting. As it relates, maybe to your March quarter demand, I'm all ears.

I think there's been a lot of commentary about leisure and travel patterns being pushed into a more flexible customer base where you can travel on Tuesdays or in the offseason. My commentary was mostly that I see the same uplift in off-peak periods, but I can't go as far as Scott Kirby, for example, to draw a causal relationship. I think we should be careful about it. What we're seeing is dollar improvement roughly the same across all periods. On a percentage basis, it's a larger percentage increase in off-peak. So, there is an opportunity for us to expand utilization into off-peak periods, but I'm very cautious about adjusting that entire strategy towards taking advantage of these opportunities because I think a big reason off-peak has been expanding is that fares are so high. As a result, you get value shoppers adjusting their schedules to find lower fares. I don't know if that's a permanent shift in behavior.

But it sounds like you'll take advantage of it when you can, right?

Yes. If you look at monthly, year-over-year percentage growth, we'll show the highest percentage growth in September 2023. That's our weakest month. It’s a function of having more opportunity in those months because fares are generally higher.

The next question will come from Scott Group of Wolfe Research.

So pretty much everyone else has given us some thoughts on the full year. I'm wondering if you could do the same. I understand Q1 will seasonally be the best margin quarter. But do you feel good about double-digit operating margins this year? Can we get back to the 12%, 12.5% we did in 2019? Just any thoughts?

Yeah, we've obviously not provided full year guidance yet. But we feel very good about the entire year. Our 2023 plan is very strong. I don't want to give specific operating income information, but our plan is to be largely back on track in 2023 to historical margin levels.

As other airlines get their labor deals done, do you worry that as rates reset higher, maybe some attrition issues start to emerge again?

I think that's a concern. Maybe less attrition issues and more availability issues. But there have been new deals. We haven't really had problems attracting folks. We're not overly concerned about that. Our attrition figures continue to underperform what we forecast them to be. So, attrition is actually lower than we’ve been planning. Intuitively, you would say yes; as others increase wages, there's competitive pressure. We haven't seen any impact of that, so far.

To the extent it emerges at some point, are there mechanisms in place to adjust if needed? Would you consider that?

We just signed a new deal at the end of 2021. We'd make spot adjustments here and there if needed to solve particular issues, but we don't contemplate any wholesale changes.

The contract we have includes rate escalators embedded in it and rate changes as well. So, our pilots will receive raises irrespective of amendments to the contract.

Operator Instructions. The next question will come from Brandon Oglenski of Barclays.

You guys, I'm not looking for specific guidance, but coming out of the IPO, we understood the business mix here. You do have a unique model relative to your competitors, with the Amazon fine and the charter fine. Hypothetically, you should probably be generating margins towards the top end of the group. I guess what is the impediment as you look forward in 2023? Or do you think getting the pilot deal done last year was the biggest issue?

Yeah, I would point out two things. One is that Amazon currently has low margins because we increased pilot pay rates faster than the escalation in the contract. Those margins are compressed currently, but that will be a temporary issue. It will improve this year and become even better in 2024, etc.

There are escalators built into the Amazon contract.

The second thing is that the highest margin opportunities are currently constrained mostly by pilots. As we improve our staffing levels, we'll be able to add particularly during peak times. This impacted us strongly during the summer of 2022, as we discussed, because we were under-allocated into markets that saw the biggest rises, especially in big city connectivity, Minneapolis and our network. We were under-allocated there because we didn't have a crew. That will be different this summer, and I believe margins will continue to expand as we progress into 2024.

In answer to your question, the thesis we had when we went public remains. We believe we can generate either the top or very near the top in industry margins going forward. Our 2023 plan reflects that. As Jude said, some temporary factors may affect us. Growth, as we continue to hit our targets, reveals plenty of opportunities. We don't believe we've reached marginal fare levels yet. There's plenty of growth prospect for us. We actually think our 2023 growth plan is achievable and somewhat modest. If we reach those numbers, we believe we will be near the top of the industry again.

Maybe just a quick follow-up on the Amazon comment. Do you have built-in cost indexes there? So, for example, if your pilot wages go up, then the Amazon contract will adjust? Or is that just the normal rate increase that you had negotiated previously?

It's normal. Pilot escalation has been lumpy. They eventually will align, but sometimes we're ahead, and sometimes we're behind.

Our next question will come from Christopher Stathoulopoulos of Susquehanna.

Jude, the comment in your prepared remarks about the 20 aircraft that are contracted out of the active fleet of 55: do you have a target level for that piece of the fleet that you want to maintain on contracted or charter? Or is that just going to move around in response to the market? Also, could you just remind us of the economics here? What utilization minimums are there, if any, and escalators that are built into those contracts?

I would look at it on a block hour basis. We would be optimized at around a quarter of our block hours allocated to fixed-fee contracts. That's because the minimums and maximums associated with our pilot contract. If those contracts service minimum hour obligations to our crews, then we're optimized for being peak to off-peak on our scheduled service. Thus, we want to keep it around 25. These opportunities aren't reliably presented to us, and we can't just select them whenever we want. So, we're going to continue to take those opportunities as they arise and build up that side of the business while trying to ensure scheduled service continues to grow. Now, each of these contracts are different. Regarding economics, in the case of the Amazon contract, for example, there’s a fixed component and then a variable component. So, margins expand as utilization goes down. Most of our fixed-fee contracts have something similar, where there’s a minimum hour obligation from the customer and then a variable component beyond that. In many cases, that variable component actually becomes cheaper for them to incentivize more flying. These businesses will produce high margins, and the stability of that operation is truly what we’re after.

On a follow-up, you said utilization-driven growth this year. Could you specify the moving pieces: stage gauge, departures, and then peak versus off-peak?

Our peak utilization numbers will be very high. The nature of the business is quite variable. Our peak utilization numbers will be 12 to 13 hours a day. Our trough utilization numbers will be in mid to high single digits.

We do see it coming down a bit in the summer as we capitalize on growth opportunities that we've discussed regarding our new markets out of Minneapolis. I would say our booking expectations for those feel good. So, there will be some seasonality in the stage length where we do longer in the first quarter and then shorten it up a bit in the summer, but it corresponds with what Dave was saying.

And for our next question, we have a follow-up from Duane Pfennigwerth of Evercore.

Maybe a small percentage of your business, but for large tour operators like Apple Leisure, can you talk about how willing you are to sell blocks of inventory to Apple Leisure and how that compares to the past? How do you think about that business when the fare environment and the demand environment are so strong?

Keep in mind that our network strategies are fairly different. We have Minneapolis origination, and that's been expanding into the upper Midwest. In those markets, particularly Minneapolis, we're creating a really strong brand, and we're investing in that brand through marketing. We intend to originate the maximum amount of that capacity through direct distribution. We're not having any issue with that. Thus that’s our strategy. Partnering with an Apple or any kind of tour operator in those markets isn’t that compelling for us. Conversely, we also augment our winter peak with summer opportunities, most notably out of Dallas, but also Houston and Central Texas, with many other future markets. Summer is such a strong peak for most markets, with what we would refer to as a price-driven consumer. We're going to be competitive during peak periods while still generating an average fare that exceeds that of the incumbents. Therefore, we are very open to block sales of our capacity with tour operators, OTAs, and other distribution partners. In my initial comments, I specifically called out contracted flying. That's what I mean, and we're negotiating those rates now. We're seeing a lot of demand from them, and we’re more than happy to offload some of our capacity into those markets through those partners' channels.

Thank you. As I'm seeing no further questions in the queue, I would now like to turn the conference back to Jude Bricker for closing remarks.

Thanks for your time, everybody. We're really excited about where we're headed. It's good to get some of the challenges of last year behind us and focus on growth and execution. Thanks for joining us on the call. We'll talk to you in about 90 days. Thanks, everyone.

This concludes today's conference call. Thank you all for participating. You may now disconnect. Have a good day and enjoy your weekend.