Under that same logic, analysts at Credit Suisse believe that Sonic Corporation (NASDAQ:SONC) will prioritize raising rates on its existing franchisees. This could cause some of its 850 franchisees, up for renewal in 2015, to resign. Although Sonic management confirmed that raising royalty rates on franchisees was possible, it stated that it would offer special lower-rate franchise licenses to franchisees that built drive-ins within certain time periods. Sonic also plans to introduce more smaller locations, which lack the entire drive-in format and are cheaper to build or franchise.
The road ahead – higher margins and higher prices
Looking forward, Sonic Corporation (NASDAQ:SONC) management repeatedly emphasized margin growth in 2013. The company has already locked in the cost of over 80% of its commodities throughout the year, and anticipates food inflation to run 1% to 2% for the rest of the fiscal year – an estimate that is in line with its industry peers. Food and packaging costs are expected to moderately improve for the rest of the year. Drive-in margins are also expected to rise to an average of 14.5% to 15.0% for fiscal 2013.
All that talk of higher margins was expected, since the company’s sales growth has been lagging for the past three years, so profits have to come from somewhere.
However, Sonic plans to raise prices 1.5% to 2.0% in May. In my opinion, this is a dangerous move. Declining revenue and weak same-store sales indicate that even though market demand isn’t strong enough to grant Sonic pricing power, the company is willing to risk denting sales growth to expand its margins. Looking at the chart below, we see that Sonic is completely depending on margin and profit growth to carry it through 2015. There simply aren’t any longer term plans to grow its revenue back to pre-2007 levels.
Source: Zonebourse.com, based on Thomson Reuters’ estimates
Versus Competitors
Sonic competes with several larger competitors, such as McDonald’s (NYSE:MCD), Burger King Worldwide Inc (NYSE:BKW) and Wendy’s. Sonic Corporation (NASDAQ:SONC) is the smallest and lacks the international exposure of its rivals. In my view, that’s a major strength – since McDonald’s, the most globally diversified, has been hit hard by troubles in Europe, its largest market. Meanwhile, both Burger King Worldwide Inc (NYSE:BKW)’ and Wendy’s are exposed to Asian and Latin American markets, which have been hit by worries regarding stagnation and inflation.
Let’s see how Sonic stacks up against these rivals.
| Forward P/E | Price to Sales (ttm) | Debt to Equity | Profit Margin | Qty. Earnings Growth (Y-O-Y) | Qty. Revenue Growth (Y-O-Y) | Same-store sales (mrq) | |
| Sonic | 16.50 | 1.32 | 1,045.63 | 6.78% | 11.50% | -1.80% | +1.3% |
| McDonald’s | 15.54 | 3.58 | 89.14 | 19.82% | 1.40% | 1.90% | +0.3% |
| Burger King | 21.37 | 3.47 | 259.52 | 5.99% | 94.40% | -30.30% | +2.7% |
| Wendy’s | 28.85 | 0.91 | 73.40 | 0.28% | 562.30% | 2.40% | +1.6% |
| Advantage | McDonald’s | Wendy’s | Wendy’s | McDonald’s | Wendy’s | Wendy’s | Burger King |
Source: Yahoo Finance, 3/27/2013
In a nutshell, Sonic simply doesn’t measure up to the big boys. Wendy’s is dominating its peers in earnings and revenue growth. McDonald’s is still the king of high margins despite slow worldwide growth. Burger King Worldwide Inc (NYSE:BKW)’ is the industry’s favorite comeback kid, with the highest same-store sales growth of the bunch. Where does that leave Sonic?
Although Sonic Corporation (NASDAQ:SONC) appears fundamentally undervalued, the company’s long-term debt – at $508.65 million versus $42.73 million in cash and equivalents – is a bright red flag telling investors to stay away. That high debt-to-equity ratio, coupled with its poor ability to grow revenue, weather dependent business model, and risky plans to raise prices, tell me that Sonic’s post-earnings pop is way too premature. Stay away from this one, unless you enjoy cherry-limeade induced sugar hangovers.
The article Sonic’s Cherry-Limeade Induced Sugar Hangover originally appeared on Fool.com and is written by Leo Sun.
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