Sonic: Now Offering Juicy Returns

Sonic Corp. (SONC), owner of an expansive chain of drive-in restaurants reported earnings per share after the close of 24 cents after adjusting for one time items, which beat consensus estimates by 20%. Although earnings slipped 2.7% compared to last year, the company did better in this recessionary environment than most expected. Revenue slid by 9.9% to $191.9 million about $10 million greater than estimates, although same store sales were a bit of a disappointment as those comparable stores’ revenue fell 5.4%. The market is shaking off the declining same store number and seems to be influenced more by the overall better than expected results, as the shares are surging ahead 11% in early trading Wednesday.

The earnings beat was exactly what Sonic needed, after the past two quarters have been negative surprises–even from greatly lowered expectations–this simply added to the stock’s troubles. Sonic’s stock had been absolutely hammered after being above $20 for much of 2008, shares dipped to a low of under $6 in March. Since that time the stock has recovered more than 50%, but still it receives our Greatly Undervalued rating. Even though earnings and sales have taken a hit during the recession, it does not seem to warrant the amount of punishment the stock has taken. When comparing the stock today versus Sonic in the past, it is clear that the stock is undervalued when adjusting for fundamentals such as earnings and revenue. For example, over the last ten years, Sonic has normally traded at about 1.52x to 2.49x revenue, but coming into the week the stock was only trading at .68x sales. That is less than half of the low end of the historical range. Furthermore, price-to-cash comparisons yield a similar result, with the stocks recent price-to-cash earnings of 4.9x compared to the historical range of 8.8x to 14.6x.

Now, while we see this stock as Greatly Undervalued, that does not mean that there are not concerns. First of all, Sonic has been aggressively marketing its value menu, and the company has been successful in driving customers to these items. However, it seems that these promotions have been too successful, and it has led to declining sales per ticket and ultimately lower profit margins. Sonic management has also realized that partnering drive-in locations have under performed their franchise locations, hurting company-wide profitability. So, the company is reducing the number of partnership drive-ins from their height of 20% down to somewhere around 12% of all Sonic restaurants. This is an on going process and the company refranchised 177 stores in the last quarter, bringing the total of partnering restaurants to just 14%.

After considering the risk/reward, we still think that Sonic is still well worth a look. The company is addressing the problems that have strained profitability in the last few quarters and the restructuring of franchising versus partnerships will provide more value to shareholders. When these changes start to positively effect the bottom line, we expect the stock will get a nice boost to the mid-teens over the next year to eighteen months.

Original post

Comments

[107Sid:]

Sonic's valuation over the past ten years is irrelevant. Overall stock evaluations yardsticks have changed (as they always do over any extended period of time) as have consumer spending characteristics and QSR saturation.

Jun 25 09:56 AM

[John Gordon:]

While Ockham's valuation point is noted, SONC has not driven enough traffic, to offset the discounting and downward average check shifts associated with its drinks and $1 value meal menu promotions. If it had, its comparable sales would be up. SONC comparable sales were down 5.4%.

These promotions were not too successful, as Ockham implies.

SONC has a high concentration of its stores in Texas and Oklanoma, which until this quarter, had been relatively less affected by the spreading recession. Therefore, one must wonder if some of the sales problem is self-inflicted by too narrow marketing.

John A. Gordon
pacificmanagementconsu...

Chain Restaurant Earnings and Economics Experts

Jun 25 10:20 AM

[User 4121:]

SONC seems to be wasting its advertising dollars. I live in the Bay Area in California, and for the past several years have watched continual ads on TV promoting Sonic. Yet the closest Sonic restaurant is about 60 miles miles from San Francisco, located in Tracy, outside of the Bay Area (and actually in the Central Valley). The Sonic ads have wetted the appetite of Bay Area residents to try out a Sonic, but they are not given an opportunity to do so by being able to visit a nearby Sonic. Meanwhile, those ad dollars go down the drain. Maybe this occurs in other areas of the country, as well.

Jul 20 02:07 PM