Earnings Call Transcript - SNCY Q3 2024

Operator, Operator

Welcome to the Sun Country Airlines Third Quarter 2024 Earnings Call. My name is Daniel, and I will be your operator for today's call. Please be advised that today's conference is being recorded. I will now turn the call over to Chris Allen, Director of Investor Relations. Mr. Allen, you may begin.

Chris Allen, Director of Investor Relations

Thank you. I'm joined today by Jude Bricker, our Chief Executive Officer; Dave Davis, President and Chief Financial Officer; and a group of others to 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, 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 earnings release and on our most recent SEC filings. We assume no obligation to update any forward-looking statement. You can find our third quarter 2024 earnings press release on the Investor Relations portion of our website at ir.suncountry.com. With that said, I'd like to turn it over to Jude.

Jude Bricker, CEO

Thanks, Chris. Good morning, everyone. Happy Halloween. Our diversified business model is unique in the airline industry. Due to the predictability of our charter and cargo businesses, we are able to deliver the most flexible scheduled service capacity in the industry. The combination of our schedule flexibility and low fixed cost model allows us to respond to both predictable leisure demand fluctuations and exogenous industry shocks. We believe due to our structural advantages, we will be able to reliably deliver industry-leading profitability throughout all cycles. Domestic industry capacity growth peaked in June at almost 7%, and the growth rate has been slowing ever since. But across our network, industry capacity reached a peak growth rate of 12%. By January, domestic industry capacity will be flat year-on-year and will be down across our network. Many airlines earnings calls have focused on a rationalization of capacity. Clearly, much of the capacity that other airlines added across our network was loss-making and has been removed. All the while, Sun Country continues to expand and produce profits and healthy cash flows. Selling unit revenues are now positive year-on-year for all future selling months. Flown unit revenues will lag, but we now expect fourth quarter TRASM year-on-year to be around flat. Based on industry schedules, I remain bullish on unit revenue trends into next year. Translating scheduled unit revenue trends into margins, we have positive trends in charter yields and cargo yields, both of which are contractual. We have mostly passed the post-COVID inflationary pressures and are expecting only modest ex-fuel unit cost increases going forward, and fuel is down. As shown in our 4Q guide, we believe we'll likely show a margin expansion. And based on current inputs, I remain bullish into 2025 as well. Another common topic on airline 3Q calls has been challenges with aircraft availability and OEM deliveries, and AOGs caused by OEMs. Again, to draw a distinction with our business, all the aircraft supporting our fleet growth for 2025 and 2026 are currently in operation with other carriers. They are either on our balance sheet as leased out until they are redelivered or committed through our cargo program. Further, borrowing costs are a common topic. Just to remind everyone, we continue to produce free cash flow and are able to self-fund our modest CapEx requirements. As such, our debt levels continue to decline even as we grow. As we ride these positive trends, this management team will primarily be focused on operational improvements and service delivery. This past summer was very challenging operationally as we discussed in the past and only to cap the season off with hurricanes and a major IT disruption. But since August 1, we have achieved a 99.5% controllable completion factor. We have an incredible team that navigates these challenges, and I'm proud to be part of it. With that, I'll turn it over to Dave.

David Davis, CFO

Thanks, Jude. We're pleased to report that Q3 was our ninth consecutive quarter of profitability, and year-to-date, Sun Country has among the highest margins in the industry. Both our Cargo segment and our charter line of business continue to produce solid growth, which has partially offset the capacity-driven pricing pressure we've experienced in the scheduled service business this year. As industry capacity continues to rationalize, we're seeing a stronger pricing environment in Q4 and into Q1 of '25. Sun Country has rapidly matched our capacity with market demand as Q3 scheduled service ASM growth fell to 5.8% year-over-year versus more than 18% in the second quarter. We're planning this growth to slow further in Q4 with scheduled service ASM growth expected to be slightly higher than 3% year-over-year. Let me now turn to the specifics of Q3. First to revenue and capacity. Third quarter total revenue was $249.5 million, which was roughly flat with the third quarter '23. Revenue for our Passenger segment, which includes our scheduled service and charter businesses, fell 3% year-over-year. Scheduled service revenue declined 5.9%, driven by an 11.1% decline in scheduled service TRASM. The quarter was impacted by industry overcapacity, the CrowdStrike outage and hurricanes in Florida. We rapidly reduced our scheduled service capacity as the quarter proceeded with July growing 12% versus prior year, but September shrinking by 10%. Given the length of our booking window, it generally takes a couple of quarters to fully realize the impact of capacity changes on flown fare levels. We feel confident that our current capacity allocation for Q4 and Q1 '25 matches customer demand. Q4 scheduled service TRASM is expected to be flat with Q4 '23 levels, and total TRASM, which includes our charter business, is expected to be up versus last year by low-single digits. Charter revenue in the third quarter grew 7% to $51 million, which was a new quarterly high for Sun Country, partially offsetting scheduled service weakness. Driving this result was a 1.7% increase in charter block hours and a 5% improvement in revenue per block hour. Charter unit revenue improvement resulted from recently renegotiated contractual rate increases and a better mix of flying. Charter unit revenue growth would have been significantly higher had lower fuel prices not reduced the fuel cost reimbursement we received from our charter customers. Over 80% of our charter revenue during the quarter came from flying done under long-term agreements. For our Cargo segment, revenue grew by 11.9% in Q3 to $29.2 million, which was also an all-time quarterly high. This growth came despite a 3.6% decrease in cargo block hours resulting from aircraft in heavy check and hurricane-driven flight cancellations in the Southeast. Cargo revenue per block hour was up 16%, driven by the impact of a portion of the rate changes implicit in our extended Amazon agreement as well as annual rate escalations. We continue to expect cargo flying to inflect sharply upward in 2025 as we take on an anticipated 8 additional freighter aircraft throughout the year. In the segment reporting table included in our Q3 10-Q, you'll see that Cargo margins improved significantly versus last year. As a reminder, the segment reporting in our quarterly filings includes allocated corporate overhead. The revised Amazon contract rates will continue to escalate as we receive additional aircraft and will not be in full effect until the second half of 2025. Turning now to costs. We continue to remain well-disciplined as Q3 CASM declined 1.9% versus the third quarter of 2023, while adjusted CASM increased 3.7%. This adjusted CASM increase was largely driven by our slowing growth during the quarter. Ground handling expenses grew 23.3% year-over-year, driven by more flying volume, higher outsourced ground handler costs and one-time credits incurred in Q3 '23, which didn't repeat this year. Regarding landing fees and airport rents, we continue to see pressure on costs due to the roll-off of COVID-era relief payments that airports have been using to minimize rate increases. This contributed to a 14.5% increase in landing fees and airport rent expense during the quarter. As we move into Q4, the slowing growth in our scheduled service business is likely to continue to put some pressure on adjusted CASM. Regarding our balance sheet, our total liquidity at the end of the third quarter was $165 million. As of October 30, total liquidity stood at approximately $184 million. Year-to-date, we've spent $42.6 million on CapEx, and we anticipate full year 2024 CapEx to be approximately $75 million. At this point, we do not expect to purchase any incremental aircraft until we begin looking at 2027 capacity. We continue to generate strong free cash flow and our leverage remains low. We expect to finish the year with a net debt to adjusted EBITDA ratio of 2.3x. Let me turn now to guidance. We expect fourth quarter total revenue to be between $250 million and $260 million on block hour growth of 2% to 5%. We're anticipating our fuel cost per gallon to be $2.47 and for us to achieve an operating margin between 7% and 9%. Our business is built for resiliency, and we'll continue to allocate capacity between segments to maximize profitability and minimize earnings volatility. With that, I will open it up for questions.

Operator, Operator

Our first question comes from Duane Pfennigwerth with Evercore ISI.

Duane Pfennigwerth, Analyst

Regarding Cargo, have you reached the full run rate on improvements in your existing business, or is there still progress to be made? Also, do you have an update on the timeline for additional cargo aircraft growth in 2025?

David Davis, CFO

Yes. So the answer is not all of the rate changes that are implicit in our new agreement are included in that number. So a portion of them occurred this year, but there will be two more increases next year as the new aircraft deliver. We're really still looking to be on track for sort of the new cargo aircraft coming in, which would be late first, early second quarter for the first one and then by late third, early fourth quarter for the eighth one. So it's a rapid ramp during the summer months of 2025. And by the end of next year, '25, all the aircraft should be operating and the rate changes should be fully in place.

Duane Pfennigwerth, Analyst

Okay. Great. That's very clear. And then just on the seasonal flying that you do in scheduled service away from Minneapolis, any new thinking in your approach there? Any kind of new markets you're particularly excited about? And are the industry capacity adjustments that you're seeing any different in those seasonal markets away from Minneapolis?

Jude Bricker, CEO

Non-Minneapolis capacity is primarily a summer issue for Sun Country. We are likely to reduce scheduled service capacity in the summer of 2025 compared to 2024 due to the cargo inductions that were discussed. Total block hours for the year are expected to increase by about 10%. We are continuing to hire and grow at a controlled and sustainable pace, but the mix will change. For the summer of next year, our non-Minneapolis operations will face some minor pressure, so it will remain mostly stable. I do not anticipate any new markets for the summer next year. We launched several markets in the summer of 2024 from Minneapolis, including some non-Minneapolis markets, but some of these will need to be put on hold to support cargo growth.

Operator, Operator

And our next question comes from Ravi Shanker with Morgan Stanley.

Unidentified Analyst, Analyst

This is Catherine on for Ravi. Just a quick question on the update on the Oman aircraft that you've leased. I was curious if those are going to continue to be on lease or if you're planning to add those to your fleet.

David Davis, CFO

Yes. Here's where we stand with that. We will definitely be adding them to our fleet. We have five aircraft scheduled to redeliver this year and go into service next year, with all of them in place at Sun Country by the end of next year. Given some OEM delays affecting other airlines, those airlines want to extend leases, and we are no exception. Therefore, it's very likely that we will extend at least a portion of those aircraft out into 2026 before they are redelivered, which aligns well with the cargo growth we anticipate next year.

Unidentified Analyst, Analyst

Got it. And then just a quick follow-up. I was curious what the RASM opportunity might be next year. Just given all this industry capacity has been coming out of the market, I was curious how you think about that impacting Sun Country.

Jude Bricker, CEO

Catherine, we just loaded summer schedules, so there's no meaningful volume of bookings past April. As I mentioned in my comments earlier, the first quarter bookings remain strong. We're seeing positive trends year-on-year. And so to the extent that we have data to look at in our own bookings beyond what other airlines have loaded in their schedules, things look really positive, but that's only through April.

Operator, Operator

And our next question comes from Brandon Oglenski with Barclays.

Brandon Oglenski, Analyst

So should we still be thinking double-digit declines in your scheduled service capacity or block hour flying next year? Is that still the bogey?

David Davis, CFO

Yes. Let me provide a quick update on that. We are still finalizing our 2025 plan, but initially, we believed we would need to reduce our scheduled service business next year by around 10%. However, considering the situation with our pilots and better availability than expected, that reduction is likely to be in the mid-single digits. We are currently finalizing these details, but it seems we will be able to operate more flights on the passenger side next year than we initially anticipated.

Jude Bricker, CEO

Yes, you can analyze the loaded schedules and compare the year-on-year data for July and June, which shows a decline in the high-single digits. As we gain more clarity on the delivery timing of the cargo fleet, there are some uncertainties regarding captain upgrades. We are committed to increasing our scheduled service capacity. Therefore, we will continue to expand as the segment mix and pilot staffing become clearer.

Brandon Oglenski, Analyst

I appreciate that, Jude. And I guess there was a comment about your booking profile; it takes a few months for capacity reductions to start showing up in higher fares or higher realized fares, I guess. Is there anything you're changing given that capacity is likely to be down next year in the way you're holding inventory or pricing?

David Davis, CFO

No. I believe that comment was primarily about leisure passengers and their tendency to book earlier, especially considering the mix of leisure travelers we have. The key point is, as Jude mentioned, we're experiencing positive trends year-over-year in booked fares. However, this will not immediately translate into flown revenue for a quarter or so, because leisure passengers tend to purchase their tickets well in advance.

Operator, Operator

Our next question comes from Michael Linenberg with DB.

Shannon Doherty, Analyst

This is Shannon Doherty on for Mike. Dave, maybe a couple for you. With other revenue up 48% year-over-year, what drove that large increase?

David Davis, CFO

The biggest driver of that is the revenue from leased aircraft, which is reflected in our P&L. We generate revenue from the aircraft we have out on lease, and that is where it is shown.

Shannon Doherty, Analyst

Okay. Got it. And how do you think about balancing deploying your free cash flow for share buybacks and other uses, just knowing that some shareholders may be limited to some extent from buying your stock due to your current market cap and trading liquidity?

David Davis, CFO

Yes. We have been running a share buyback program for some time. Our free cash flow profile is strong. We are currently paying down debt quickly, and this will continue in the future. I do not anticipate us engaging in share buybacks for the next few months. However, as we approach 2025, our cash is increasing rapidly, and we will reassess this situation. There's always a trade-off for us with a relatively limited float, which makes it difficult for people to buy and sell the stock. Buying back shares tends to make this issue worse. Nevertheless, we believe our shares are a solid investment at this price. Later this year and into early next year, we will revisit this matter.

Jude Bricker, CEO

Just one thing on cash balances. The end of the third quarter is the annual trough in the seasonality of our cash balances. So when you look at the balance sheet on the Q, just keep that in mind.

Operator, Operator

Our next question comes from Tom Fitzgerald with TD Cowen.

Tom Fitzgerald, Analyst

Just going back to the health of the booking window, especially in Minneapolis with carriers like JetBlue leaving. Could you touch on like how 7-day rolling yields have trended over the last 6 or 8 weeks or so?

Jude Bricker, CEO

Certainly. The 7-day trailing fares compared to the same period last year have increased across every selling month as we look ahead to significant volumes. I also want to highlight the impact of the calendar shift for leisure carriers like ours this year, which is very beneficial. With a late Thanksgiving and midweek Christmas and New Year's, the setup is ideal, and the late Easter extends our winter travel season. Typically, there's a weak period between Thanksgiving and Christmas, but that period is relatively short this year. Furthermore, we have an extended winter booking cycle due to the late Easter. These factors are contributing positively to bookings. In our largest markets for this winter—Minneapolis, Las Vegas, Los Angeles, Orlando, Cancun, and Fort Myers—we're witnessing very positive trends. December bookings in West Florida haven't been significantly impacted by hurricane-related challenges. While we expect to see an effect in November, it seems to subside by the time the December schedule begins. Overall, bookings are looking strong.

Tom Fitzgerald, Analyst

That's very helpful. As a follow-up, once we reach 2026 and have the full complement of Amazon planes in operation, how do you anticipate the seasonality of cargo block hours will play out in the first and second halves? Any insights on that would be greatly appreciated.

Jude Bricker, CEO

If you go look at sort of the revenue profile of the cargo business, it varies. The main variance quarter-to-quarter, honestly, is just check volume, like what aircraft are going through check at any one time. So the business has a great advantage for us in that it's quite flat throughout the year, and we expect that to continue. A little bit harder flying during Amazon Prime periods, but not that much. So it's a great, very stable business, and we expect that to continue as all the aircraft are in.

Operator, Operator

And our next question comes from Scott Group with Wolfe.

Scott Group, Analyst

I want to follow up on the cargo revenue per block hour. I see it's up 7% over last quarter and 16% year-over-year. Which of these figures do you think is more indicative of the new rate with Amazon? I'm trying to figure out if we should expect the upcoming two increases to be similar in magnitude to the most recent one. Ultimately, I'm trying to understand where this revenue per block hour might be by the second half of next year.

David Davis, CFO

Yes. The 16% year-over-year figure includes the annual rate increases, while the other number you mentioned reflects the quarter-over-quarter change. I would say that this quarter-over-quarter figure is more indicative of one aspect of the new contractual rates. We anticipate two additional increases next year, which collectively should be roughly comparable to the increase you referenced. I won't provide details on the contractual rates here, but by the end of 2025, everything will be fully in place.

Jude Bricker, CEO

I just want to bring up also the rate structure has a fixed component and then a departure component and a block hour component. So utilization, mostly subject to heavy check schedules, has some impact on the per block hour rate that you're looking at in the financials. So there's not only rate changes, there's also a little bit of noise associated with other things.

Scott Group, Analyst

Yes, that makes sense. You mentioned that fares booked are looking good, RASM is steady in Q4, and leisure travelers tend to book early. Do you believe the positive fare trend will result in an increase in RASM in Q1, which is your significant quarter? Or has there been enough early booking that we might not see an increase in RASM in Q1?

Jude Bricker, CEO

Yes, we're not going to guide to Q1, but my point was only that the inflection happened a few months ago. So we were selling into flown months, October, November, December at a negative fare versus last year up until a few months ago. Now it's positive. It will take a while for total TRASM to catch up. But the further out in the schedule we look, the longer time we'll have of these positive booking trends, and the more bullish we become.

David Davis, CFO

Yes. So the plan is still sort of coming together. CASM is going to be up because the passenger business is down, and the passenger business is what drives CASM, obviously, not the cargo business. I would say we're looking at numbers, let's just call it, mid-single-digit up next year in CASM, but that's subject to change here as we finalize our plan.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn it back to Jude Bricker for closing remarks.

Jude Bricker, CEO

Hey, guys, thanks for your interest. I hope everybody has a great weekend. We're really excited about what we're seeing on booking trends, which we've talked about quite a lot this morning and look forward to giving you another update in 90 days. Have a great day, everybody.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.