Sonic Corp. - Not Good Enough?

| About: Sonic Corp. (SONC)
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I was asked about my thoughts on Sonic by a reader.

I discuss the just reported performance in the context of what I look for in a stock within this competitive sector.

A lot of "what-ifs" concern me, although there are key positives.

I was asked about my thoughts on Sonic Corp. (NASDAQ:SONC),so in this article I am initiating coverage. I imagine what prompted the inquiry was the just-reported quarter after hours. I will discuss the performance of the name but have to tell you I am not very familiar with this stock. I am however familiar with the company, with Sonic having (finally) come to the Albany, N.Y., area recently. For those who are completely unfamiliar with the name, Sonic is a fast food restaurant. You may have seen advertisements for the chain where they are featuring new products. What makes Sonic "Sonic" is the old fashioned drive up. You come in, look at the menu in your car (or at picnic tables, etc.) push a red button, place your order, and it is brought out to you. Burgers, fries, and an extensive drink menu. It's a competitive and crowded sector but the chain has managed to grow to national scale in its 60 year history. One thing I love about the name is that 90% of stores are locally owned and operated, and the company now has 3,500 plus locations. It is important to understand that the company is in the process of refranchising, but is also facing a tough consumer. That said, can the growth continue?

To address this question and the question of my reader, we must turn to recent performance. A cursory glance at the last year of reported quarters reveals that the company has consistently delivered earnings beats but has had trouble meeting the bottom line. In the just reported first fiscal quarter, this trend continued. The company delivered a top line miss and a bottom line beat. Let's first address sales.

Total sales and revenues from leases and royalties were $129.6 million. This is down from last $145.8 million. This is a pretty strong decline of 11.1% year over year. Company Drive in sales were just $87 million, vs. $103 million last year, a whopping 15% decline. Franchise royalties and fees came in at $40.1 million, vs. $39.9 last year. While sales declined markedly I was at least pleased to see that the costs to generate these revenues fell year over year. Total costs and expenses were $102 million vs. $119 million last year, falling over 14%. The bulk of expenditures are payroll and benefits, coming in at 31.7 million, as well as of course food and packaging costs, which were $24.1 million. Taken as a whole, I was pleased to see the costs come down, especially since revenues declined, but these declines are worrisome.

Turning to income, we see that net income was $11.3 million, versus $12.5 last year. This is a decline of 9% year over year. Thanks to a lucrative buyback however, earnings per share were flat. They came in at $0.24 vs. $0.24 as well last year. Not good enough. One of the key drivers of performance is same store sales. Truthfully, this is actually the most important metric I look for in a name like this. And I did not like what I saw. Same store sales were disappointing. The dropped 2%. There was a 2% drop in franchise drive-ins as well as a 2.4% decline in company drive-ins. Frankly, this should scare any potential investor away right now. Commenting on the quarter, Cliff Hudson, Sonic's CEO stated:

Our first quarter results reflect a sluggish consumer landscape and exceptionally strong prior-year performance. Our unit growth, capital structure, refranchising and technology initiatives are performing well. We refranchised 56 drive-ins during the quarter and remain confident that we will complete our targeted refranchising transactions prior to the end of the third fiscal quarter, leaving us with a more efficient, higher-margin portfolio of company-owned stores. We are also pleased to have repurchased 2 million shares in the first quarter of 2017, representing 4% of shares outstanding, while continuing to invest in the people, development and content that will drive our consumer-facing technology to the next level.

Bottom line, I am unimpressed. I realize that the company is in the middle of a transition and came off of a strong year. But there are a lot of "what-ifs" here. Looking ahead for the year, the company expects adjusted earnings per share to be in the range of down 7% to flat year-over-year. Not good enough. The all-important same-store sales for the system are expected to be down 2% or flat at best.

The good news is the company sees royalty revenue growth from new unit development and plans to open 65 to 75 new franchise drive-ins. Margins are respectable, anticipated to be 16-17%, though this is really going to coincide with same store sales and product costs. I like the company's dividend and the yield is at semi-attractive levels coupled with a generous buyback. However, in this crowded space, there are many choices. I would avoid the name.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.