Minnesota-based ultra-low cost passenger and cargo airline, Sun Country Airlines (NASDAQ:SNCY) debuted on the public markets this Wednesday. The company soared over 51%, as investors bet on an economic rebound and a return to flying. Airlines such as Sun Country have seen a return to pre-pandemic revenues, giving investors confidence that growth going forward is possible.
The budget airline sold 9,090,909 shares of its common stock priced at $24 per share, raising $218.2 million in its initial public offering (IPO). Underwriters have an option to buy an additional 1,363,636 shares at the IPO price. The company will have raised over $250.9 million if underwriters fully exercise their purchase options. The company plans to use funds to pay off loans incurred as a consequence of the CARES Act, while also covering over fees and expenses associated with the IPO. The residual will be used for general purposes.
According to the company’s S-1/A registration form, Sun Country was hit hard by the global health crisis, swinging from a $46 million net profit in 2019, to a $3.9 million loss in 2020. Revenues collapsed from $701 million in 2019, to a loss of $401.5 million in 2020. Revenues could have been worse, save for a deal with Amazon (NASDAQ:AMZN) to fly cargo. A decline in bookings, however, drove them into loss territory.
The company offers flights from its headquarters in Minneapolis/St. Paul. Sun Country flies to over 50 destinations in North America, Central America, and the Caribbean. The airline flies through more than 80 routes.
Positive Signals
Jay Ritter, of the University of Florida, has shown that companies with revenues of over $100 million prior to going public, perform better than the average performance of other IPOs. They usually rise an average of 42.8% over three years.
Sun Country has already achieved revenues of $458 million. IPOs with revenues of over $100 million also slightly outperform the market (+0.5%), and outperformed it on a risk-adjusted basis by 4.3%.
Air travel grew at an average of 7% per year prior to the pandemic.
The company is a hybrid carrier, operating as both a charter and cargo carrier. This provides the company with a floor in a crisis, diversifying risk in ways that traditional airlines cannot. The importance of this is seen in the ability of the company to earn revenue during the pandemic, thanks to its agreement with Amazon to carry cargo. Sun Country operates 10 planes as part of its exclusive cargo agreement with Amazon.
Both the charter and cargo markets are growing at impressive rates. The cargo market has been growing at $5 billion a year. The charter market has been growing at 6% per year.
Plainly, there is a large and tangible market opportunity for Sun Country. Sun Country has been profitable and growing. We can give the company a pass over its 2020 loss, noting not only that it made a loss in exceptional circumstances, but that its diversified segment model allowed it to keep ticking over when many airlines were grounded.
Profitability is a great sign that an IPO has found a competitive advantage. Ultimately, a company’s returns to shareholders will reflect its profitability. Indeed, Sun Country is among the most profitable airlines out there. This can only attract investors and push up the share price, at a time when investors are rotating funds to traditional sectors in anticipation of an economic rebound.
Negative Signals
At present, the company is destroying shareholder value. The company has a return on assets of -2.86% and a return on equity of -1.38%.
Margins are also terrible. Sun Country’s profit margins are -0.97% and its operating margins are -11.75%.
The company does show a positive operating cash flow of $364,000.
Much of this can be ascribed to the effects of the Covid-19 pandemic, but airlines have been, in the long run, difficult places to build competitive advantages.
The Trouble With Airlines
Even when things are going well, airline executives find ways to steal defeat from the jaws of victory. Airlines are notoriously unprofitable and the industry itself is riddled with indiscipline.
Airlines like Sun Country undercut traditional players, leading to a race to the bottom. A few airlines, like Southwest (NYSE:LUV), have been able to find ways to offer low cost solutions in a profitable way, over the long-term. Yet Southwest is an anomaly.
Competition in the markets is so fierce that success often means cutting prices. Airlines simply do not have pricing power.
Players like Sun Country have a simple play in mind: grow seat capacity at rates above the industry average. Yet, excess capacity has the effect of driving down prices and with it, profitability. Indeed, travel has seldom been cheaper.
As we saw, Sun Country’s margins are terrible.
Customer satisfaction in the industry is terrible. Brand loyalty is so low it barely exists. Customers go to the carrier that can give them the best deal. Nobody flies with such-and-such an airline even if they are more expensive than everyone else, out of brand loyalty. Price is everything.
Consistent bookings and free cash flow growth are difficult to get. In the long run, investing in an airline is extremely risky.