Monday, July 17, 2017

Is This Tiny Airline About to Challenge Delta Air Lines?

For the first time in several years, Sun Country Airlines has a CEO with lots of experience in the airline industry. Some big strategic changes could be coming soon.

For most of its 35-year history, Sun Country Airlines has been a perennial also-ran in the airline industry. It's hard to survive as a smaller airline in the U.S., and Sun Country has been further hampered by periodic mismanagement.

However, Sun Country may finally be serious about improving its competitiveness. Last week, the company hired longtime Allegiant Travel executive Jude Bricker as its new CEO. Bricker's appointment will likely usher in a new strategy at Sun Country Airlines. This could give it a better shot at competing with market leader Delta Air Lines in Minneapolis-St. Paul, Sun Country's main base of operations.

Weak profitability has been a constant

Sun Country Airlines was lucky to survive the Great Recession. The combination of record oil prices and plunging demand caused several airlines to go bust in 2008. Moreover, Sun Country found itself in the midst of a scandal that year, as its chairman and CEO was arrested on fraud charges. The company was only able to survive by filing for bankruptcy and forcing employees to take a massive temporary pay cut.

Sun Country eventually emerged from bankruptcy in 2011. However, it hasn't joined in the recent airline industry renaissance -- and profitability has been sinking recently.

During the 12 months ending in March 2017, Sun Country Airlines posted a meager operating profit of $3 million, putting its operating margin well below 1%. In the prior 12 months, Sun Country's operating profit had been significantly higher, at $32 million. Yet even then, its 6% operating margin was far worse than the double-digit margins common at other U.S. airlines.

Professional management is coming

In addition to its small size, Sun Country has also suffered in recent years from not having an experienced management team. In 2011, the company was bought out of bankruptcy by the owners of Cambria: a Minnesota-based company that specializes in kitchen countertops. Additionally, Sun Country was led for most of the past two years by Zarir Erani, an executive with no previous experience in the airline industry.

By contrast, new CEO Jude Bricker worked for Allegiant Travel -- a highly successful ultra-low cost carrier -- for more than a decade, most recently as chief operating officer. Thus, Bricker will bring fresh ideas and much-needed industry know-how to Sun Country Airlines.

Costs are too high

Right now, Sun Country's biggest problem is that its costs are too high for a low-cost carrier (especially a small one with little pricing power). During the 12-month period that ended in March, Sun Country's cost per available seat mile (CASM) was 10.57 cents. For comparison, Allegiant posted CASM of 8.36 cents during the same period, despite facing significant cost pressures related to its ongoing fleet transition.

Meanwhile, Delta Air Lines' CASM has been around 13 cents recently -- but Delta can generate much higher unit revenue due to its full-service hub-and-spoke business model.

With more than 70% market share at Minneapolis-St. Paul International Airport, Delta is by far Sun Country Airlines' most important competitor. (Nearly all of Sun Country's scheduled flights touch Minneapolis-St. Paul.) In order to thrive, the carrier will need a bigger cost advantage.

Can Sun Country be fixed?

At this point, the clearest path forward for Sun Country Airlines would be to transform itself into an ultra-low-cost carrier. Its new CEO is already familiar with the ULCC business model from his time at Allegiant. Furthermore, Frontier Airlines successfully reshaped itself as a ULCC a few years ago and has become strongly profitable since then despite facing customer backlash in its hometown of Denver.

One of the most basic ways that ULCCs keep costs down is by squeezing as many seats as possible onto their planes. Re-configuring Sun Country's fleet might take a year or two, but it would be a straightforward way to reduce unit costs.

Ultra-low-cost carriers also generally implement substantial fees for using high-cost amenities like reservations call centers and agent-assisted check-in. By prodding customers to take advantage of self-service options like booking online and printing a boarding pass at home, they can further reduce their costs.

Sun Country Airlines could also go a different route, such as trying to position itself as a "premium" brand like Virgin America. However, such a transformation would be far tougher to pull off. Converting to an ultra-low-cost carrier business model is both the most promising and the most likely path that Sun Country will take under its new CEO.

(Adam Levine-Weinberg - The Motley Fool)

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