Sun Country Tries to Strike While the Iron is Hot

This seems like an unlikely time for an airline to try to go public. After all, every airline is losing absurd amounts of cash as demand has plummeted during the pandemic. But hey, when you’re owned by a private equity group, going public can never come soon enough because the owners want to cash out. And so, Apollo-owned Sun Country has filed its S-1 with the SEC so that it can try to pour money into Apollo’s coffers during the worst downturn the industry has ever seen. The thing is, this is probably the right time for Sun Country to swing for the fences.

There’s nothing quite as fun as the experience of going through an airline’s S-1. Yes, even privately-held airlines have to release some information publicly via DOT rules, but you really can’t get a look under the hood until an airline goes public and opens it books up. So, what did I learn?

Let’s start with how Sun Country views itself.

Sun Country Airlines is a new breed of hybrid low-cost air carrier that dynamically deploys shared resources across our synergistic scheduled service, charter and cargo businesses. 

I just really, really hate the word — and every derivative of — “synergy.” Also, the grammar snob in me cringes when the Oxford comma isn’t used. So, we are not off to a great start, but let’s overlook that. The point here is that Sun Country is cobbling together three lines of business to make what it hopes is considered a successful airline.

Scheduled Service

For years, Sun Country has made its money on flights from its Minneapolis/St Paul home base during the winter and spring break. Here is a look at operating margin by quarter using DOT Form 41 data for the last decade before the pandemic began.

Sun Country Operating Margin by Quarter

There’s no question that Q1 is the undisputed winner, and that was often the quarter that either made or ruined the year for the airline. You’ll see it did start to change in 2019 after strategic changes were put into place. Q1 was still the all around winner, but the other months weren’t nearly as bad. And really, that’s the best Q4 performance in recent history thanks to what looks like a surge in charter business plus higher bag fee collection.

That’s good news for now, but it’s tough to actually dive into this in greater detail since there isn’t much more given in DOT reports. That’s where I was hoping the S-1 would fill in the gaps. The problem with the S-1 is that it doesn’t show any quarterly results. It just shows annual results and then in 2020 stops after the first three quarters. For an airline with this much seasonal variation, that’s essential detail.

Here is how Sun Country describes its scheduled service plan:

Our scheduled service business combines low costs with a high quality product to generate higher TRASM than ULCCs while maintaining lower Adjusted CASM than LCCs

It’s that dreaded “tweener” strategy. What this really means is that Sun Country does not have costs as low as the ultra low cost carriers (Allegiant, Frontier, Spirit), and it doesn’t seem to expect it can get there. Instead, it wants to have costs lower than the regular low cost carriers (defined as JetBlue and Southwest). The thing is, Sun Country’s fare structure and offering is more like a ULCC, but it needs to get a fare premium over the ULCCs because its costs are too high. So it has backed into this tweener model of offering what it says is a better product.

Yes, the product is mostly unbundled but not entirely. You get entertainment streamed to you at no extra charge, soft drinks without a fee, and maybe slightly better seat pitch.

As we all know by now, Sun Country is using the “endless summer” scheduling model where it just moves airplanes on to routes where there’s a ton of demand at different times of the year. It wants to be a spill carrier that just races from market to market, scooping up passengers wherever it finds them. Sun Country has a more consultanty-sounding name for this: Agile Peak Demand Scheduling Strategy.

Put it this way: in 2019, Sun Country flew 38 percent of its available seat miles in the top 100 peak demand days and only 15 percent during the bottom 100. That year, it had only 3 percent of routes flying daily year-round which even makes Frontier look consistent at with 8 percent. Southwest had 67 percent, Spirit 42 percent, and Allegiant 2 percent.

Charter Service

Sun Country has long run a decent charter business, but I guess I didn’t quite realize how big it was.

Our diverse charter customer base includes casino operators, the U.S. Department of Defense, college sports teams and professional sports teams. We are the primary air carrier for the NCAA Division I National Basketball Tournament (known as “March Madness”), and we flew over 100 college sports teams during 2019…

As of 2018 [for narrowbody charters], we had strong market positions in the casinos and tours customer segments, the U.S. Department of Defense and college sports customer segments with an estimated market share of approximately 33%, 29% and 18%, respectively.

Apparently the charter business is strongest in the fall, since I assume that’s when college sports need the most charters? I’m not really sure. But that’s a good business to help fill planes in the fall when Sun Country can’t fill them with regular, scheduled passengers. Still, I wish we could dive in to understand how profitable that business is, but we really can’t.

Sun Country uses what it calls “power patterns” to route airplanes on scheduled flights and then on to charter flights. It’s all connected tightly together, and it’s hard to know exactly how to allocate the costs to the different services. The problem with charter is that if someone decides it has extra airplanes and wants to get into the business, it can use lower bids to win business away.

Cargo Service

Before the pandemic, Sun Country signed a deal to fly 10 cargo 737-800s for Amazon’s Prime Air. You can think of this deal as Sun Country flying for Amazon as, say, Mesa flies for United.

Here’s how it works. Amazon came to Sun Country and said, “Listen up. We’re going to give you 10 airplanes painted in our colors. You just need to put them on your operating certificate, use your crews to fly them, do regular line maintenance (but not heavy checks), and provide insurance. That’s it.”

Amazon loads and unloads the airplanes and owns them outright; Sun Country is just the operator. For this great privilege, Sun Country only had to offer up a board seat to Amazon if it wants it (so far, it doesn’t), give warrants for 15 percent of the airline, and accept a relatively low revenue rate paid partially as a fixed monthly fee and partially per flight.

There is a lot clouding the revenue picture here, but Flightradar24 kindly pulled the dates these airplanes made their first flights for Amazon, I made some assumptions, and I came to monthly revenue per aircraft likely somewhere in the $550,000 to $750,000 range. This is very rough by nature, just because there are all sorts of issues like vesting warrants, an initial start-up payment, and more that made me start ripping my hair out. But if you assume it’s in the range, that’s roughly about 30 to 40 percent of the revenue per aircraft per month that Sun Country was making before the pandemic on its combined scheduled and charter business.

The natural question is… are the costs also 30 to 40 percent lower? Were I a betting man, I’d say that they aren’t. I assume that Sun Country had to trade lower margins in order to gain stability and revenue growth. That doesn’t necessarily mean it’s bad, but it is probably not as lucrative as a successful scheduled strategy would be. Still, Sun Country liked this plan enough that it even agreed to take 2 more airplanes to make it an even dozen.

Why This Makes Sense

I do look at this with a skeptical eye, because, well, I look at everything with a skeptical eye. But here’s how I see it. Sun Country has found a way to insulate its business from downturns to an extent. The airline admits that charter business hasn’t been hit nearly as hard as scheduled, and of course, Amazon is booming. The lows for Sun Country should be higher than the lows for others… and they are.

Sun Country proudly pointed to earning a 7.4 percent operating margin for the first nine months of 2020 which appears to outperform the bigger US airlines. That number is misleading since it includes the CARES Act PSP money which should definitely not count. Without that, the operating margin falls to -14.5 percent. It’s a loss, albeit one that most other airlines would love to be able to post.

This is why right now is a good time for Sun Country to go public. In comparison to others, it’s business looks fairly solid. The thing is, with lower downside risk comes lower upside potential. I’m going to assume that the margins on Amazon and charter are not going to change much. But when scheduled service begins to do well again, the other airlines will race past Sun Country into positive territory.

For now, Sun Country looks like a well-performing airline that has revenue growth potential. If you’re going to try to monetize it, that seems like a good time to try it. Now we just have to see if investors are willing to buy into the story.