Revised Amazon deal to boost Sun Country’s cargo profits

Sun Country Airlines’ cargo activity and profits will significantly improve under an amended transportation services agreement to operate freighter aircraft for Amazon’s e-commerce parcel network, an executive with the leisure carrier said Friday.

Under the revised contract announced Thursday, Amazon will place eight additional Boeing 737-800 converted freighters with Sun Country (NASDAQ: SNCY) to operate on its behalf. The retail giant also extended the contract until 2030. The aircraft, which Amazon (NASDAQ: AMZN) is transferring from Atlas Air’s air operating certificate to Sun Country’s, will be delivered between the first and third quarters next year.

Minneapolis-based Sun Country, which has operated a dozen 737-800 freighters for Amazon for four years, will earn profit margins roughly equal to its passenger business once all the aircraft join the fleet after negotiating improved terms, Chief Financial Officer Dave Davis said on a briefing call with equity analysts. Flight hours for the cargo fleet will increase by 60% to 65% next year because of the additional aircraft and then continue to grow on an annual basis at 13% to 15%, he added.

Sun Country generated cargo revenue of $100 million in 2023, up 10% from the prior year. Cargo represented about 9.5% of the airline’s total revenue.

“Once we are fully ramped towards the late third quarter of 2025, the contribution margin of the Amazon flying will be basically on par with the contribution margin of our passenger flying on a historical basis,” Davis said.

Sun Country’s operating margin for passenger operations was 14% in 2023 and negative 5% for cargo. Cargo is expected to align with passenger margins by 2026. Negative cargo margins do not reflect the contribution of the Amazon flying to profitability because they are heavily burdened with overhead costs in the financial statements, but the magnitude of the cargo improvement will be about 19% to 20%, Davis explained.

Talks with Amazon about an expanded role for Sun Country began about six months ago and intensified in the past two or three months.

Amazon in May agreed to end its partnership with Atlas Air, which will gradually wind down flying for the e-commerce marketplace over the next 15 months. Atlas Air also operates 16 Boeing 767 freighters for Amazon, which will reallocate at least 10 of them to cargo airline ABX Air between now and December. No reasons were given for the breakup.

“It’s our belief that Amazon has focused on reliable service above all else to serve their customers. So we think we’ve demonstrated that over the years and been rewarded with these additional aircraft. They’re our most important relationship at the company, and we want to continue to provide that level of service as we go forward,” Davis said.

Sun Country will temporarily cut scheduled passenger capacity by about 11% in 2025, mostly during the slow seasons, to accommodate the transition with pilots and other resources, and then begin adding passenger flights again in 2026 as more planes join the fleet, management said. The reduction in scheduled passenger operations comes as passenger business is softening because of excess capacity across the industry and slower demand from leisure travelers. Management said second-quarter revenue will come in at the low end of guidance, about $256 million, and operating margin will be 4% to 5%, instead of a 7% upper range.

Davis foreshadowed an improved deal with Amazon at Bank of America’s annual transportation conference in mid-May, saying high cargo margins at the contract’s start in early 2020 have since come down and that Sun Country needed to take more aircraft and negotiate better terms to achieve acceptable profit. An increase in pilot costs after the pandemic is the primary reason behind the lower margins, he said.

Amazon hasn’t informed Sun Country yet about the new routes it will fly, but the airline hopes the extra freighters will enable it operate a more efficient schedule, which will contribute to the bottom line, the CFO added.

Sun Country has virtually no ownership costs associated with growing the fleet because Amazon provides the aircraft, which are leased from an aviation investment company, and is responsible for loading and unloading. Davis acknowledged startup costs, such as pilot training, will be in the low-digit millions of dollars.

One of the benefits of a hybrid business is that pilots are interchangeable among passenger, cargo and charter flying, but Davis said Sun Country will need to hire more pilots to support the larger fleet.

Amazon pays Sun Country a flat amount per aircraft operated as well as by the number of flight hours.

Under the original transportation services agreement, Sun Country issued warrants giving Amazon the option to purchase up to 15% of the airline’s stock. No additional stock warrants were issued with the amended agreement, but management said the time for exercising the options could be accelerated because they are based on the amount of total revenue Sun Country receives and revenue will now come in faster than before.

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