Sun Country Airlines Holdings, Inc. (NASDAQ:SNCY) Q1 2024 Earnings Call Transcript

Sun Country Airlines Holdings, Inc. (NASDAQ:SNCY) Q1 2024 Earnings Call Transcript May 7, 2024

Sun Country Airlines Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Sun Country Airlines’ first-quarter 2024 earnings call. My name is Jill, and I will be your operator for today’s call. [Operator Instructions]. 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: 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 on management’s current beliefs, expectations, and assumptions and are subject to risks and uncertainties. Actual results may differ materially, and we encourage you to review the risks and cautionary statements outlined in our earnings release and our most recent SEC filings. We assume no obligation to update any forward-looking statement. You can find our first quarter 2024 earnings press release on the Investor Relations portion of the website at ir.suncountry.com. With that said, I’d like to turn it over to Jude.

Jude Bricker: Thank you, Chris. Good morning, everyone. Our diversified business model is unique in the airline industry due to the predictability of our charter and cargo businesses, we’re 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 are able to reliably deliver industry-leading profitability throughout all cycles. Operational excellence is a core tenant of our product. It’s critical to our scheduled service customers and justifies our growth with our charter and cargo customers.

Among the 11 public mainline carriers, Sun Country again had the best completion factor at 99.7% for 1Q. Congratulations to our employees, especially our frontlines for delivering excellence this past quarter. In the first quarter, we saw yields reset off their post pandemic highs. These fare declines were partially absorbed by our continued momentum on costs. Our CASMx declined slightly in 1Q in spite of significant increase in heavy aircraft visits. Diligent cost control, scheduled service growth, along with the effects of our buyback program, produced flat EPS for us last year. Our adjusted operating margin of just over 18% was at the lower end of our expectations coming into the quarter. This variance is mostly due to close in March bookings finishing less strong than in 2023.

March is still a great month for us, we had gross margins, profit success in excess of variable costs approaching 50%. However, March bookings made through January would have indicated an even stronger month. As lows remains high, most of the variance can be attributed to industry capacity growth across our largest markets. Our response to changes in the fare environment or fuel price inputs, is to adjust marginal capacity so that we continue to produce positive and industry leading results. When possible, we may allocate surplus capacity into our charter and cargo segments. So looking into the rest of the year, we’re currently allocating too much capacity growth in off-peak periods based on selling fares. While we’re committed to May, I expect us to make some significant capacity trends in September through November.

Some of that displaced capacity will provide growth opportunities in cargo and charter. Summer peak continues to sell well and should remain mostly as scheduled. Also, a quick note on the Easter shift. And early Easter reduces the peak winter season and explains about 10 percentage points in fare drop in April 2024 or about $3 million. This revenue isn’t recoverable in March because it’s already at peak capacity. Finally, on fleet activities. With our recent aircraft purchase, we now have a control fleet of 63 aircraft. Seven of these aircraft remain out on the operating lease, and two more are in induction process to enter service in late 2Q. Once all these aircraft are in operation by late 2025. We’ll have fleet capacity to produce about 40% more block hours than we currently operate.

As we already paid for that growth, we won’t require any aircraft CapEx. And so expect CapEx to fall to maintenance levels, which is about $50 million to $75 million per year. And with that, I’ll turn it over to Dave.

David Davis: Thanks, Jude. We’re pleased to report strong Q1 results, including record revenue and an adjusted operating margin of 18.2%, which we expect to be at the top of the industry. Our quarterly results again demonstrate the resiliency and earnings power of our diversified business model as this is our seventh consecutive quarter of profitability. The staffing driven constraints we’ve experienced for over a year now have eased and we were able to grow our scheduled service business as rapidly as we intended to. Year-over-year unit costs fell for the second consecutive quarter despite significant increases in maintenance and airport related expenses. It’s important to keep in mind that our unique operating model is the opposite of the high utilization carriers.

Our diversification across scheduled service, charter and cargo operations leads to resiliency through business cycles. Where we’ve seen large increases in OA capacity in some of our markets, which has pressured yields, there are significant opportunities for accretive growth in our charter and cargo businesses, and we’ll continue to allocate capacity to the segments generating the highest returns. Let me turn now to the specifics of the first quarter. First, on revenue and capacity. In the first quarter, total revenue grew 5.9% versus Q1 of last year, to $311.5 million. This is our highest quarterly total record — revenue on record. Scheduled service revenue plus ancillary revenue grew 2.8% to $227.4 million, also the highest on record. Scheduled service TRASM decreased 11.7% to $12.2, as scheduled service ASMs grew by more than 16%.

Total fare declined 11.3% to $196.41, while we maintained an 87% load factor. For the month of March, we saw our scheduled service load factor at 89%. First quarter is historically our strongest, and we expect to see a seasonally driven fall in unit revenue from Q1 to Q2, exacerbated by the Easter shift into Q1 and the nearly 20% growth in scheduled service ASMs we’re expecting to see in Q2. Charter revenue in the first quarter grew 2.4% to $47.3 million on a block hour decline of 3%, driving charter revenue per block hour, up 5.6%. If you exclude changes in fuel reimbursement revenue from both Q1 of this year and Q1 of last year, charter revenue grew 6.5% over the period, and revenue per block-hour was up 9.8%. Ad hoc charter revenue grew 29% versus Q1 of last year, and charter flying under long-term contracts was 75% of total charter revenue versus 80% last year.

First quarter cargo revenue grew 2.5% to $23.9 million on a 1.1% increase in block hours. As a reminder, our cargo rates in — sorry, 1.1% decrease in block hours. As a reminder, our cargo rates increase annually at the end of December. Let me turn now to costs. Our first quarter total operating expenses increased 7.5% on a 9.6% increase in total block hours. CASM declined by 5.4% versus Q1 of ’23 while adjusted CASM declined by 0.1%, marking our second consecutive quarter of year-over-year CASM declines. As our pilot availability issues have eased, we’ve been able to grow flying through higher aircraft utilization, which was eight hours per day in Q1, up 9.6% versus Q1 of last year. Our declining CASM came despite increases in both maintenance expenses and higher airport costs.

Maintenance expenses grew by 29% year over year, driven by an increase in the number of airframe and engine overhaul events from three in Q1 of ’23 to eight to this quarter, while the rolling off of COVID relief payments to airports helped to drive a 34.6% increase in rent and landing fees. Now let me turn now to the balance sheet. Our total liquidity at the end of Q1 was $179 million, which incorporates $11.5 million in share repurchases that we made during the quarter and $29.7 million in CapEx spend. At this point, we do not expect to purchase any incremental aircraft until we begin looking for 2026 capacity at the very earliest. We anticipate full year 2024 CapEx to be well below $100 million. We continue to maintain a very strong balance sheet and our net debt to adjusted EBITDA ratio at the end of Q1 was 2.5 times.

Since we do not have a significant debt burden, we have flexibility in how we deploy our cash. Turning now to guidance. We expect second quarter total revenue to be between $255 million and $265 million on block hour growth of 8% to 11%. We’re anticipating our cost per gallon for fuel to be $2.93. And for us to achieve an operating margin between 4% and 7%. Our business is built for resiliency, and we’ll continue to allocate capacity between our lines of business to maximize profitability and minimize earnings volatility. With that, we will open it up for questions.

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Q&A Session

Operator: [Operator Instructions]. First question comes from Ravi Shanker with Morgan Stanley.

Ravi Shanker: Thanks. Morning, everyone. Dave, can I just start with where you ended off and talk about the difference in the segment realignment or reallocation of capacity. Can you go into a little more detail on kind of what you guys are doing in terms of specific actions to absorb some of that excess capacity and some of your oversupplied markets and kind of how long that will take?

David Davis: Yeah. I’ll let Jude speak to that mainly but let me just say it at a high level here. So I think basically our capacity is committed for Q2, and that explains part of the margin pressure that we’re seeing into the second quarter. There’ll be opportunities in the back half of the year to reallocate some of that capacity, particularly in off-peak times away from our scheduled service business and into our charter businesses. In the longer term to the medium term, we continue to look for opportunities to allocate the resources we have across all our segments. There’s opportunities in the cargo business that present themselves, we’re going to presume. We’re going to allocate our pilot capacity, our training capacity, the capacity of our company between the segments based on profitability.

If there’s continued pressure in the scheduled service business, we’re going to allocate to the other segments that we think there are opportunities in both of our other lines of business.

Jude Bricker: Yeah, the focus is in the Labor Day through Thanksgiving period to try to pick up more charters, but it usually is that way. So incremental allocations are going to be marginal. So it’s mostly going to be capacity cuts of scheduled service flights that don’t make variable contribution.

Ravi Shanker: Got it. As maybe just to follow up on that, how do we think about modeling from 2Q to 3Q kind of the relative normal seasonality, given the kind of extremely low starting point for 2Q.

Jude Bricker: That’s a fair point. I mean typically, we would see 2Q and 3Q perform equally. This 2Q has both over-capacity in April and May and an Easter shift. So our expectation is we outperform 2Q and 3Q.

Operator: Your next question comes from Duane Pfennigwerth with Evercore ISI.

Duane Pfennigwerth: Hey, good morning. Thanks. So if we just play back your ability to kind of flex up in the peak periods, you were obviously constrained for an extended period of time. Those constraints started to ease and now you have a greater ability to kind of flex up in these peaks, which theoretically was going to be at higher incremental RASM. And so I guess, relative to your expectations going in, how has that gone? And I guess more importantly, what do you take with you going forward? So how are you thinking about flexing up in future peaks, maybe relative to how you managed peaks in the first quarter?

Jude Bricker: The biggest surprise is that the scheduled service network didn’t absorb the growth in the off-peak periods the way we expected it to do. Keep in mind, we designed the network based on its performance largely of the prior year on a granular level. So this slide on this day did well, let’s add another. This market was cut right at the end of the peak period but was performing strongly, so maybe it can go into the off-peak period and still contribute. And those decisions on the margin didn’t produce the results that we thought they would. So most of the difference between where we expected fares to be and where they actually turned out to be, can be explained through more seats in markets, not just from us, but from OAs. And there’s a really strong correlation between the change in route, the downward pressure on fares, the change in unit revenue in a market, and its seat growth, as you would expect.

And in off-peak periods when there just isn’t a lot of margin to give, those markets, those flights should have been not in the schedule. The change — what’s really interesting about this time is that the change in the selling fare environment didn’t really start until mid-February. And then we’re looking at 2Q and saying, okay, well, these fares are coming down, some of these flights aren’t going to be positively contributing, but we should leave them in there to protect the sold seats on those flights. And further like, fare fluctuations are pretty common. This one just lasted on the way through the selling period. So I think we made the right decision in 2Q, keep these markets going and then we’ll adjust to the new environment in the post summer trough.

Duane Pfennigwerth: That’s great. So basically, the learnings that you’re taking here from your approach to off-peak, 2Q is not really the period to measure that change it’s more kind of 3Q second half. Is that fair?

Jude Bricker: Yeah. But Duane, keep in mind that we’re always adjusting utilization based on the inputs of fare environment and fuel. So this can reverse itself as well. But the marginal capacity that comes in or out of the schedule largely resides in the off-peak periods. So think of our business is there’s one awesome month, that’s March. There’s about six good months: February, April, June, July, December, August. And then there’s a really bad month in September. And then there’s kind of a couple that are meh for. And when we think about variable capacity, it’s always allocating into like those shoulder months that can absorb or not based on the fuel price and fare environment.

David Davis: Yeah. But it is fair to say, Duane, obviously we have more of the second quarter sold than we did the third quarter or the fourth quarter. So our ability to adjust the schedule gets better the further out we go. It is somewhat limited in Q2 at this point.