Allegiant Air, Sun Country Airlines: matching capacity with demand

Anup Mysoor: Welcome to CAPA Live and welcome to the CFO session. My name is Anup Mysoor and I will be your moderator for this session. On the panel today, we have Greg Anderson, the CFO of Allegiant calling in from Las Vegas, and we have Dave Davis CFO of Sun Country Airlines calling in from Minneapolis. Greg, Dave, welcome. Let's crack straight on to a commercial update because I think you're two unique airlines, where you can provide the world with some good news. First, you Greg, Allegiant what a year it's been in the US domestic market, in the three months to 30th of June versus the same quarter in 2019, your revenues were down a teeny weenie 4%. However, your net income was up 35%. You've bounced back. When I look at your August operational figures compared against 2019, your capacity is up 12%. Please, can you provide some background to what's happening in your market and what have been the growth drives?

[Allegiant] We're just really adept to serving matching capacity with demand, given our kind of high variable cost structure, low fixed costs. So I think overall that's been good for us. We've seen a lot of positive signs as of late. I think peak to peak, I would see a lot of demand in leisure travel here in the States

Greg Anderson: "Sure. Happy to and thank you for having us here Anup. So, I think just maybe overall thinking about Allegiant and how we serve the US, we're a 100% domestic carrier in the US, we focus 100% on leisure and we're nonstop, so convenient. So as we think about the opportunity we've had, leisure has kind of come back quicker. I mean much more quickly than in corporate or international, which are still lagging behind. Our data suggests, and I may be a little dated on this, but about a 15% increase in leisure demand. So that's been helpful, of course, for us, we have a very broad network. So we serve over 130 cities. That's more than any other carrier in the US, save the big three. So that's been helpful as we found pockets of demand.

"We're just really adept to serving matching capacity with demand, given our kind of high variable cost structure, low fixed costs. So I think overall that's been good for us. We've seen a lot of positive signs as of late. I think peak to peak, I would see a lot of demand in leisure travel here in the States. Off peak we've pulled back capacity significantly by way of, for example, in the peak of the summer, as compared to September. And September is less leisure oriented for us, our capacity comes down by about 50%. So again, just having that flexibility in the model has served us well."

AM: Thanks Greg. Dave, if I could ask you for some country in the three months to 30th of June, you had load factors of 77% revenues of USD149 million and a net income of USD52 million, which is, a one third margin, which is exceptional and you are leisure focused airline as well. Can you provide some background on how you maintain such huge margins and also give us some update on the booking curve and what do you see for Thanksgiving and Christmas?

[Sun Country] We fly when demand is there. We don't fly when it's not there. So we have a significant charter operation, which is the military, sports teams, casino traffic. And then starting in 2020, we have a pretty significant cargo operation where we're flying 12 freighter aircraft for Amazon.

Dave Davis: "So that margin in the second quarter you got to be a little careful with, we had a big one time adjustment to a few line items in there, given our private equity ownership. But still we generated strongly positive margins even without that. I think our business on the passenger side, particularly the scheduled passenger side is pretty similar to the Allegiant model, we're 100% leisure focussed. We sort of match capacity with demand. We fly when demand is there. We don't fly when it's not there. I think the difference is probably we're also diversified across a couple different segments. So we have a significant charter operation here, which is the military, which is sports teams, casino traffic, we do a lot of. And then starting in 2020, we have a pretty significant cargo operation where we're flying 12 freighter aircraft for Amazon.

"So really sort of continued strength, let's say faster improvement in the charter market. And a lot of strength in our Amazon business is sort of served us well both through COVID and then into 2021. At the same time, particularly in the second quarter, we saw probably similar to Allegiant, very strong rebound in passenger demand that pulled back a little bit in, let's say mostly late August into September, very much Delta variant related. In the last three to four weeks there's been another pretty rapid acceleration for us in our scheduled passenger demand. So particularly during peak time. So as we head into the holiday season, Thanksgiving, Christmas, we're definitely seeing strong demand. And then this airline is very centred on bringing people in the north to warm weather destinations in the southern US, Mexico, the Caribbean. So the first quarter is our big quarter, as opposed to some other airlines. It might be the third quarter, but ours is the first quarter. So we're gearing up and we are really bullish about what the first quarter looks like."

AM: The language you both use is so different from what I hear across the pond of the Atlantic. But let's move on. Greg, you mentioned 100% domestic, but aren't you considering international as well?

[Allegiant] International has always been of interest for us. Where we sit today there's a lot of low hanging fruit here in the US. We keep our eye south of the border. We'll continue to focus domestically to position ourselves in the medium to long term to go down and fly international. So that's a long term aspiration for us, but continue to try and just knock off some lowing hanging fruit here in the US

GA: "Yeah. We have been for some time, international has always been of interest for us. Where we sit today there's a lot of low hanging fruit here in the US, the lower 48. We serve about 600 markets today. Our network team feels that there's about 1000 incremental markets in the US that we could serve. And of those markets, both the 600 we serve today and of the incremental, roughly 80% of them have no direct nonstop competition. So we feel a good opportunity for us. We keep our eye south of the border. I think international, that would make the most sense for us. The natural evolution is down in Mexico or south there. But until that, the low hanging fruit becomes lower internationally. I think we'll continue to focus domestically to position ourselves in the medium to long term to go down and fly international. So that's a long term aspiration for us, but continue to try and just knock off some lowing hanging fruit here in the US."

AM: Thanks. Dave, you mentioned the relationship with Amazon and cargo. And cargo has typically not been a feature of LCCs. How do you see that relationship with Amazon developing and cargo in general in the LCC space?

[Sun Country] One of the sort of unique features I think is we're all 737-800 right now, both on the scheduled service, the charter side, and the cargo side. So our pilots are fully cross utilised, all of our overhead operations, maintenance. It's all cross utilised across all three segment

DD: "Yeah, so that's a good question. First of all, unlike the passenger side of the business, we don't necessarily control the growth on our cargo business. It's driven by Amazon's demand. How many aircraft they're going to add. So we haven't planned for substantial growth on the cargo side, really for a couple reasons. One is we can't necessarily control it. Two is we want to really focus on our scheduled service growth here as demand is coming back as strongly as it is. So the cargo business is a really important feature of the company. It's a steady cash flow generator for us that serves as a really solid base for variability on the passenger side of the business.

"I think a few things that are unique, this is definitely probably not something I would see a Spirit or a Frontier getting into, which is very high utilisation type stuff. That's not what our model is. One of the sort of unique features I think is we're all 737-800 right now, both on the scheduled service, the charter side, and the cargo side. So our pilots are fully cross utilised, all of our overhead operations, maintenance. It's all cross utilised across all three segments. So it's really not as unique operationally as it would be probably for some other carriers."

AM: Thanks. Let's talk a little bit about your business models. Greg at Allegiant, you are the first airline I think worldwide, but definitely in the US, to recover capacity fully and your market cap has surpassed pre-pandemic levels. For the second quarter, your adjusted unit costs fall below the ULCC benchmark of six cents. Are you concerned about the new US startups? I think it's Avelo, started by Allegiant president, Andrew Levy and David Neeleman's, Breeze.

[Allegiant] Before the pandemic we had about USD500 million in cash. Right now we have about USD1.2 billion. Net debt went from a billion pre pandemic down to now USD200 million

GA: "What I'd say for us is that overall, I think we're pretty well insulated from competition or at least where we sit today. I mentioned the 80% of our routes non-competitive, we have a really strong balance sheet. Before the pandemic we had about USD500 million in cash. Right now we have about USD1.2 billion. Net debt went from a billion pre pandemic down to now USD200 million. I say that because we have a strong balance sheet or a strong credit. And I think we have a big opportunity in front of us, whether that be through buying aircraft at discounted prices, or whether that be through the network and opportunities to expand and grow there.

"We know Andrew well, he obviously as Allegiant, grew close with Andrew, some of the guys over at Breeze, some of their C-suite Lucas Johnson and Trent Porter, and even what they've done over at Sun Country, Dave and Jude and Chris Allen and team, there's some Allegiant DNA there as well. But what I would say is, everybody that, what I'm referencing here, they're just very data driven. I think we're all probably keeping an eye on everyone else, but we're going to run our own race here at Allegiant. And I'm sure Dave and his team will do the same along with Andrew and the Breeze team. And we're going to do what's best for Allegiant, we can't be complacent, got to continue to get better. And I think there's a lot of opportunity for us and I like forward position. I think we're very, very well positioned here at Allegiant, not only to do well in a post pandemic world, but to thrive. But we'll keep an eye on them and I'm sure they'll be doing the same for us as we do with all other carriers too."

AM: Dave, if I could put that difficult question to you, your adjusted CASM is 6.35 with a target to get to below six. How are you going to keep the model going so successfully with new ULCC capacity coming in?

[Sun Country] We actually lowered our gross debt load during the pandemic. Didn't take any additional debt. We have a significant cash balance now, given the IPO that we did in the positive cash flow generation that we have

DD: "I guess I would sort of echo a lot of what was just said. I mean, Avelo and Breeze are sort of off doing their thing. There's really kind of no overlap with what our markets are. We have fundamentally, I think, a different model than at least Breeze does. We have a lot of large city origination. We sell through GDSs. We have an open distribution system. So I don't see us as sort of direct head to head competitors with those guys. I think we just see a lot of opportunity for low cost carriers in the US and for airlines like Sun Country. So, there's plenty of room for all of us here.

"Again, I think echoing what Greg just said, we came through the pandemic, we actually lowered our gross debt load during the pandemic. Didn't take any additional debt. We have a significant cash balance now, given the IPO that we did in the positive cash flow generation that we have. Plenty of opportunity out there on the used aircraft side. We think we're really well positioned right now. And to be honest, those guys aren't really a factor for us and our planning, but there's plenty of room for all of us I believe."

AM: Greg, let me ask you, what would've been a controversial question in Europe, is government support. You've had the PSP and you've had secured loan programme through the CARES Act. In Europe, Ryanair has taken the EU to court and is stage one successful saying that national equity injections into the national flight carriers breaches level playing field rules. How about the US support? Do you think there's been additional support for the big three or big four?

[Allegiant] With or without the support we would've been able to get through this. So I think it was fair across the board. I'm not going to complain. I don't know that here at Allegiant we needed all of it, but we were appreciative of what they did and everything and happy that the industry's going to come through this and be in a good spot to help overall the US economy recover

GA: "I think in hindsight I think at Allegiant we would've been with or without the support, we would've been able to get through this, just given the flexibility of the model and the things that we talked about, like the low fixed cost, high variable cost structure, just the way we performed. But what I'd say, I think the government, it was appreciative though, going through the pandemic and I think Dave can attest, those were some dark days and you just didn't know what was going to come out of the other side of it.

"They came in and once they helped all carriers, including us, that was a backstop to really kind of get things going again, make sure that we had the infrastructure to help when the economy was ready, that we were there to help kind to rebound the economy and everything. So I think it was fair across the board. I mean, I'm not going to complain. I don't know that here at Allegiant, like I said, we needed all of it, but we were appreciative of what they did and everything and happy that the industry's going to come through this and be in a good spot to help overall the US economy recover."

AM: Thanks. Dave, slightly different question, all your responses till now, haven't really mentioned the big three, but in your whole market of Minneapolis, you have a big bear. And so how do you think the big three, big four are going to compete against your model when they see your margins?

[Sun Country] Delta and Sun Country work very well together. And here's why. Delta has the vast lion share of the corporate market of the business market. That's not a market we're interested in competing in, we don't sell first class seats. We don't go head to head with Delta in their trunk routes or trunk markets

DD: "So the biggest overlap for us by far from a legacy standpoint, it's clearly Delta. We have the dominant share here at Minneapolis. I think actually Delta and Sun Country work very well together, a complimentary way here at Minneapolis. And here's why. Delta has the vast lion share of the corporate market of the business market here. That's not a market we're interested in competing in, we don't sell first class seats. We don't go head to head with Delta in their trunk routes or trunk markets. We're very leisure focused, very peaky, very day of week, very seasonal. So we think we don't really represent head-to-head competition with Delta in most circumstances.

"I think the other thing to remember is Delta's not going to have 100% of Minneapolis. There's going to be competitors here. And the question is, who do you want those competitors to be? I think if you look at our unit revenues, we're disciplined. We don't sort of trash the fare environment. And we think that works well for us. I'm not sure if some of our competitors would sort of have the same behaviour here. So, as I said, I think we're pretty complementary with Delta. I mean, we're very careful not to go head-to-head with them. And I think we work together well."

AM: Moving on to what a lot of the audience wants to hear about is the fleet and fleet financing. In very quick numbers, Allegiant, 108, A320 family, about three quarters in the A320s and a quarter of those are of A319s vintage, about 15 years. Sun Country Airlines, 48, 737-800, 36 passenger, 12 cargo, vintage, 16 years old, very different from an LCC elsewhere. So Greg, for Allegiant, the CAPA Database shows your fleet is majority operating leased. I don't think that's the case. I think your fleet is mainly owned with finance leases with the banks, but I'd like to hear more. And in 2020, you raised about USD115 million from the bank marketing secured financing's and USD88 million in sale lease backs. Can you tell us a little bit more about your fleet financing strategy? Do you finance on an aircraft by aircraft basis, batches of aircraft? How long your bank financing is? Are these full payout structures considering the vintage? And who are your typical lenders and lessors?

[Allegiant] The vast majority we own our aircraft and there's some bank debt on that. It's like 85% of our aircraft we own, and perhaps some bank debt on those. 35% of our aircraft are unencumbered. So our strategy is more around the owning aeroplanes rather than leasing. We have USD1.5 billion in total debt. I would just say half of that's corporate debt, the other half's aircraft debt.

GA: "Sure and hopefully I'll get all those questions, or I'll be able to answer all those questions. So just to hit the first point. Yeah, I think you said majority operating leases. No, vast majority we own our aircraft and there's some bank debt on that. So I think it's like 85% of our aircraft we own, and perhaps some bank debt on those. 35% of our aircraft are unencumbered. So our strategy is more around the owning aeroplanes rather than leasing. We did do some sell lease backs during the pandemic. I wouldn't read too much into that. Those sell lease backs were more of a retirement strategy for us. There was about six older 319 aircraft that we just wanted to raise some capital on. And so we felt like that was an elegant way to do that.

"As far as just how we think about aircraft debt versus just overall debt. But we have USD1.5 billion in total debt. I would just say half of that's corporate debt, the other half's aircraft debt. The way we typically go about that aircraft debt is as we buy aircraft and we buy used, primarily used aircraft. It's often onesie's, twosies here and there sometimes we'll get bigger or aircraft orders. But what we generally want to do is go out and buy those in cash. And then if we want to put debt on them later, we'll go to the bank markets and do that. And with the bank markets, we generally look for a shorter amortisation period, like a five year tenor. So we're paying down that debt rather quickly, get it off the books. So, that's been overall the strategy on that side.

"I think as we look at 2022, we announced on the last earnings call, a capital lease. And so that was about 11 aircraft with ex-Alaska aircraft. So essentially like seller finance. We won't have to put much capital in those with the capital lease, but we will own those aircraft at the end of the day. That's how we feel about those. As we think about the different partners we have, I think you asked, which banks that lend to us and partners on the lessor side, ACG air lease, AerCap, GECAS. On the lessor side, as far as banks that lend to us, you got like, DBJ, Fuyo, I mean, all over there's so many, B of A, SNBC, Common Bank Wealth of Australia, which is a terrific partner of ours and others. So, we have a lot of relationships throughout the world. That's been really helpful to us, particularly in the pandemic. A lot of those partners showed up and they were there to lend to us, as you noted with USD115 million in bank financing. And then also with those sell lease backs. I hope, did I get everything, I don't know if I missed anything on that."

AM: Greg, I didn't hear a US bank name.

GA: "Oh, well there's Bank of America. We do a lot of business with them and Wells has been a partner of ours as well. So, there's a few in there."

AM: Dave, if I could put the same question to you, because I was reading that you are planning on expanding the fleet by about six aircraft a year. And first question is, how do you source your aircraft? And the second question is the financing strategy and whether there's a different sourcing and financing strategy for cargo.

[Sun Country] All the new aircraft that we're acquiring we either own outright, have some bank debt on them, or are part of a finance lease, but basically we own them. And that's going to be the model that we have going forward. We believe it's a lot more efficient for us. We acquire midlife aircraft and operate them for a number of years.

DD: "We don't have any order book here whatsoever. So all of our aircraft are essentially acquired. You can tell by the average age, they're essentially midlife 737s that we acquire from various sources, whether its other airlines, whether it's leasing companies. Right now, there's sort of a rich ground in airlines that have essentially filed for bankruptcy around the world and have put some fleet onto the market. So that's been a fertile ground for us lately. So we're kind of all over the place, sourcing 737s and there seems to be plenty of aircraft out there, particularly as MAX deliveries have come back and airlines are retiring aircraft. So the sourcing hasn't been a problem for us. And we've gotten what we think are some pretty great deals.

"From a financing perspective, this current management team all showed up here in 2017, 2018 timeframe. At that time, 100% of the fleet was operating leases. And some of them really uneconomic. We have sort of worked hard for the legacy fleet to convert as many of those over to owned aircraft as possible. And all the new aircraft that we're acquiring we either own outright, have some bank debt on them, or are part of a finance lease, but basically we own them. And that's going to be the model that we have going forward. We believe it's a lot more efficient for us. We acquire midlife aircraft and operate them for a number of years. From a maintenance perspective, from other perspective, there's a lot more value to us from that model than there is from operating leases. So, that's going to be what we continue to do. We've done a double ETC. Some of the banks that participated in our IPO have been very helpful on the aircraft finance side, Goldman Morgan Stanley, Deutsche Bank have all been big participants for us.

"The cargo fleet for us is kind of ideal. We don't own those aircraft. Amazon owns the aeroplanes, we just fly them. So Amazon owns the aircraft. They handle all the ground handling. We provide the pilots, some maintenance, insurance, that's a CMI deal. So we don't need to acquire those aeroplanes."

AM: To move to a very unique part of your model when it comes to fleet. If I could put the next question to you, Greg, for Allegiant on residual values, Allegiant is less worried about residual values as you aim to be the last operator of the aircraft, and you aim to fully consume the aircraft and engines. So you use the aircraft and engines for as long as economically viable, and then you break up the aircraft engines and use the remaining life of the spares. Have I got that right? And are you unique among LCCs to have started and operated this model?

[Allegiant] We've grown and become larger, and during the pandemic where we looked at some leases, we did reduce our exposure on the residual values. And so we negotiated terms of which, when we return those aircraft to the lessors, that there's not going to be any costly maintenance top ups

GA: "I think in a lot ways, as broadly speaking we're unique, not just with the way we manage our aircraft and engines. In terms of managing residual values, I think you're generally correct. Although I would say, as we've grown and become larger, and during the pandemic where we looked at some leases, we did reduce our exposure on the residual values. And so we negotiated terms of which, when we return those aircraft to the lessors, that there's not going to be any costly maintenance top ups. But as we like to think about it, we want to be able to manage all our major assets, engines, aircraft, and kind of cradle to grave and anything in between. We're getting better and better at that I believe, every asset that we own, whether that be an engine or aircraft on that side has a baseball card.

"And it goes through a profile of how it's operating, how much maintenance status is left, how much to reinvest back in that asset. And as we look at those types of opportunities, whether or not we reinvest, we retire, that's how we manage it. And I think we've done a good job of monetizing the remaining green time. And we'll continue to be able to do that. And during the pandemic, we retired eight total. And once you get all through it, eight aircraft that we were able to save meaningfully on the maintenance side of the house. And so we look at it in that way, just kind of as asset managers. But yeah, I think we're unique in a lot of ways. And that's one as well."

AM: Dave, for Sun Country elsewhere in the world, LCCs believe that the first six years of an A320, 737 life is the beginning of life honeymoon. I mean, one airline in India, IndiGo Airlines, basically just does six year leases and hands them back brand new aircraft. Most LCCs operate new aircraft for 12 years on leases. However, you are an end of life honeymooner. That sounds like a difficult honeymoon. If you could tell us some more.

[Sun Country] We buy these midlife aircraft, it varies widely in age, but our intention is to essentially run these aircraft for the remaining useful life. And then we'll harvest whatever we can at the end. The cost savings associated with that model, more than offset what would be incremental ownership costs of owning new aircraft.

DD: "I think our model is probably pretty similar to what Greg just mentioned. We buy these midlife aircraft, it varies widely in age, but our intention is to essentially run these aircraft for the remaining useful life. And then we'll harvest whatever we can at the end. In my distant past, I worked for an airline we had a huge DC9 fleet, over 100 aircraft, and it was exactly the same strategy. As these aircraft sort of age, spare parts become cheaper. There's a lot of spare engines on the market. So you can harvest green time. We're kind of seeing a lot of that same thing play out right now. The cost savings associated with that model, more than offset what would be incremental ownership costs of owning new aircraft.

"We pick up some fuel burn savings and some other things that would offset all that. But these savings that we see are the costs that we incur because of our old aircraft strategy are worth it when you compare to the other costs that we'd incur with new aircraft. So I think that's sort of part of it. The other thing I think that's really important to keep in mind is our business model is different. So if we were running aircraft 12 or 13 hours a day, let's say some of the carriers you mentioned, it would be a lot different, but we're looking at utilisation of nine hours. So we don't run the aircraft as hard as we would if we were a typical ULCC. So the need for a new aircraft is sort of diminished."

AM: Well, the market agrees with you. Greg for Allegiant, your market cap in 2019 was USD2.5 billion. It went down to a billion in 2020, and now it's USD3.5 billion. The market is more bullish about you today than they were in 2019. Why? And in the second quarter, you raised USD335 million of new cash from the equity market when you were already cash flow positive. I mean, why raise more money now?

[Allegiant] We outperformed during those difficult times and investors took notice of that. So we think we really have opportunity to continue to grow and expand this model and grow profitably. So I think the investors picked up on that and it rewarded us through our share price and market cap.

GA: "Well, good questions. I think on the first half of your questions, the market cap for Allegiant and why it's larger today than it was pre-pandemic is probably threefold. One is just the way we performed during the pandemic. We outperformed during those difficult times and investors took notice of that. And this is a resilient model of Allegiant. And as Dave mentioned earlier, the ULCC space, are winners coming out or viewed as potentially winners coming out of the pandemic. Our balance sheet came out of the pandemic not overly burdened with debt, expensive debt. As I mentioned before, net debt and cash balances, we have a really strong balance sheet coming out of this. So I think that too was helpful. And then the opportunities ahead, I think there's a lot of opportunities and we mentioned in the used aircraft market and the network side of the house. So we think we really have opportunity to continue to grow and expand this model and grow profitably. So I think the investors picked up on that and it rewarded us through our share price and market cap.

"The second part of your question on that equity offering, the way I've been describing that is that was just more of an opportunistic offering. It was our share price at the time of the offering or the strike price was roughly USD220 per share. So it wasn't that the depth of the pandemic, it was at the high end, nearly at an all time high. We wanted to use that USD350 million as capital to kind of supercharge growth and strengthen the balance sheet and make sure that when those opportunities come, we're able to take, participate in those opportunities, whether that be aircraft negotiations or just expanding and things of that nature. I will say one last thing on the equity raise is that, over the years, since we've been a publicly traded company, we've repurchased in the open market, 6 million shares at an average repurchase price of USD98. In the equity raise, we issued 1.5 million shares. So well below what we've repurchased. And that 1.5 million shares was the strike price of USD220, though it was somewhat, we think a shrewd capital move as well."

AM: Thanks. Dave, for Sun Country, congratulations on your IPO. To IPO, when most other airlines are trying to recover from a pandemic. That's amazing. I mean, what motivated the timing of your IPO?

[Sun Country] Coming through the pandemic, we didn't take on any additional debt. And then that was viewed against a backdrop of a world where everyone perceived leisure demand coming back much more rapidly than corporate demand. And that's what our sweet spot is

DD: "Yeah, I think a lot of what we saw happening with frankly, Allegiant and some others, and basically the whole industry in terms of valuations really rebounding in the first quarter of 2021 kind of really drove our timing to take advantage of that, those strong market tailwinds. And then we performed really well through the pandemic. We were fully ramped up with Amazon by the end of 2020. So the timing worked perfectly from that aspect as well. Strong balance sheet coming through the pandemic, we didn't take on any additional debt. So I think the market viewed all of that very favourably. And then I think that was sort of viewed against a backdrop of a world where everyone perceived leisure demand coming back much more rapidly than corporate demand. And that's what our sweet spot is. And I think that's been born out. So I think it was sort of built both those internal factors as well as just the backdrop of a huge rebounded leisure flying here in the US."

AM: With that I just say hats off to both your teams, at Allegiant and Sun Country Airlines, you make this industry proud. Thank you.