There is no question that Sonic Corporation (SONC) has arguably the most distinct business model in the quick-serve restaurant industry. However, is this enough to validate an investment in the franchise?After lowering its outlook for the fiscal year, from between $0.55 - $0.60 to $0.50 - $0.55 per share, Sonic announced on June 21, 2010 that its earnings for the third quarter were a disappointing $0.18 per share. This figure is lower than what analysts predicted by 1 to 4 cents per share, and even includes a 3 cent tax benefit. Without including special items, this marks a year over year decline of almost 40%.
Without doubt, these numbers do not sound good. With a poor performance this quarter, it is doubtful whether the fourth quarter, typically Sonic's strongest, can be a successful one. Considering the cyclical nature of the company's business, the implications of poor summer sales are that the winter will be long and hard. The market has shown that it is fearful of what is to come; the stock has declined more than 16% in the last two weeks.
Justified or not?
Such a drop carries with it the question, is the business really deserving of such a downgrade, or did investors overreact? As a whole, Sonic's prospects are not all that bad. Its drive-in or drive-thru format, in which customers can either order through a speaker from their parked car in a booth or get their food to go, has developed quite a following. The self-acclaimed "Ultimate Drink Stop" serves very popular drinks and the rest of the menu has relatively good value. A new Chief Marketing Officer has been brought in from Pepsi, Danielle Vona, and she seems like a good gamble by the company.
It is difficult to say if Sonic can get back on track. Its business model says that it can. The franchise has room to grow, with only four locations in New York and two in Massachusetts, and so far it has shown success when it has tried its luck in new markets.
There are no guarantees, though. The debt situation is not the best; stockholder equity was negative until F1Q10 and net tangible asset value remains in the red. Management has taken steps to fix this and plans to eliminate more than $100 million of liabilities by the end of this calendar year. However, this means that if sales are not satisfactory, the deleveraging will find its way to the bottom line and make for further earnings disappointments. Adverse developments in the prices of beef or any other of Sonic's inputs could negatively impact the stock price as well.
But does everybody already know this?
It is possible the market has priced this in, as Sonic is below the industry averages at 12.8x earnings and 6.9x EBITDA. Still, as the winter months come and less people want to eat in their cars during snowstorms, the stock may take another tumble.
For investors with a longer investing time frame, this small cap has an interesting story and a possibility of strong growth. If the currently-depressed sales can recover and margins revert back to their historical levels, the current price will be looked back on as very cheap.
This is a big "if" though. Any steps in the wrong direction for the economy, prolonged depreciation, a double dip, etc., and sales might not recover. Without a strong conviction on where the United States is headed financially, investing in restaurants is a risky practice.
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Reader Comments (Page 1 of 1)
6-25-2010 @ 10:36PM
D said...
Just like so many good places in the past that were good to eat at, I remember Sonic while living in Arizona back in the mid 70s, and again in Texas back in the mid 80s. Both era's and times experiences were pleasant. However, I believe due to expansion, the product quality has gone down. It is my belief that, just like so many fast food restaurants that have gone the way of corporate expansion, quality always seems to end up taking a dive. There's always a need to attempt to keep costs down and it ultimately affects the food. Shiny new buildings and fancy interiors unfortunately do not make the taste and food go down any easier.
If there is a problem with sales at Sonic, as well as any other fast food franchise, take a closure look at the real quality of the food first. I'm sure you will definitely find that the problem lies there first. And of course, service plays a huge factor as well. But in some cases, it could easily be due to a lack of management and cleanliness as well. I for one would not eat at a fast food restaurant that does not spend any time cleaning it's tables restrooms.
Additionally, not a point to the problem but a area of concern. Many fast food restaurants have over-the-top ice fill machines for its soft drinks. I have found in several places that most of these fast food restaurants do not keep the covers on due to the constant need to fill them. Though this may not sound like a real problem, over time, it does become a health related issue. The problem lies with dust and flying insects that may their way into the ice machine, and ultimately into your soft drink.
Fast food restaurants are trying so hard to compete for dollars at the risk of cutting corners and low quality food at seemingly low prices. But the overall cost saving to consumers is more a risk the cost benefit. The low cost products are generally industrial grade food product fillers that make up much of the fast food items unsuspecting people often buy. That is, hamburgers with additive and fillers, as well as hotdogs, chicken and fish fillets, shakes a host of other products.
Only a few restaurants that have not yet become public, such as In-And-Out, still attempt to keep the ingredient as fresh as possible without the compromise to quality, by keeping it simple and cost affective. However, there is word that they too may expand. And if that does happen, there may eventually be a compromise to quality to their product. Hopefully, they realize that their success is due in part to the high quality of their food and not the bottom line.
While there have been many great old time places to eat, such as A&W, Wendy's, McDonald's, Sonic, just to name only a few, these companies have settled to compromise on quality and freshness while still trying to remain relevant and public. But this will soon catch up with them. Their bottom lines will collapse and their franchises will fail. McDonald's is a prime example of quality gone totally out the window. They're just a pale reminder of a good memories gone long ago.
6-28-2010 @ 8:32AM
rgolub said...
to get good real ice cream, as an example, you must go to a small specialty ice cream shop. We had one in our little town. It failed as an economic enterprise. Cheap stuff will run good stuff out of the market. Sorry, but that is the truth. Most people have no taste or sense.
7-06-2010 @ 2:25PM
DW said...
Sonic's problems aren't hidden in some confused business-school maze of byzantine market plans gone awry. Sonic has been on the downslope for years now arising from the commission of two unforgivable restaurant industry sins - bad food, and bad service.
Time was that Sonic had excellent quality control and kept reasonably close eye on its franchises, but that day is long past. Owner independence has turned into inconsistent offerings, with decidedly non-subtle efforts at cutting costs telegraphing a flailing service entity.
From franchises putting customers through thirty-plus minute waits for food, to burgers that had turned into paper-thin meat offerings with super-size buns, it doesn't take an MBA to realize that competitors are offering better product and better service at better prices.
There may yet be hope for Sonic; just this spring, Sonic introduced a "reinvented" hamburger with thicker meat and a decidedly less "poofy" bun, combined with a new emphasis on fresh toppings such as tomatoes and lettuce. Sonic has also pushed hard to spread the word on its "real ice cream" desserts, and without doubt, both products are better.
It's at least a step in the right direction.
What remains to be seen is whether the change will roll over into franchise consistency, such as fries and tots that aren't consistently undercooked, accurately filled orders, or an end to annoying practices like charging 25 cents for a cup of water when one of Sonic's carbonated options just doesn't sound appealing.
Its too early to tell whether Sonic's efforts to right itself are in time to save itself in the cut-throat fast food industry. At least, however, someone is listening to a call to get back to basics, and leading Sonic back to making good, simple burgers once again.