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Sonic Corp. (SONC): Ordering Up Margin Expansion

 December 20, 2012 01:53 PM

(By Kevin Donovan) When on the road down South or out West, our better half invariably demanded her favorite hamburger and a cherry limeade – the trademark choices delivered to your car door by Sonic (SONC), the drive-in restaurant chain whose stock price has delivered as well this year.  Although near their 52-week high, shares have more to gain, in our view.

Trading at forward price-to-earnings multiple of 13.56, more or less the S&P 500 forward multiple as calculated by Birinyi Associates, Sonic's prospects rate a premium, we believe.  Here's why:

  • Operating leverage: Margins at the drive-in level increased 220 basis points to 16.5% in the fiscal fourth quarter (ended August).  With same-store sales seen rising in the low single digits and a revamped point-of-sale system, more improvement in margins could be forthcoming.
  • Free Cash Flow:  The company's franchise model generates considerable and predictable free cash flow.  Sonic expects $45 to $55 million in free cash flow in fiscal 2013.  That cash can be used to buy back shares.  Sonic bought 4 million shares in fiscal 2012.
  • Valuation:  On a forward PE basis, Sonic trades below both McDonald's (MCD) and Burger King Worldwide.  Using a multiple midway between MCD and BKW, Sonic could be valued north of $15 per share.  Shares are up 55% year to date and have traded as high as $10.94.  The 52-week low is $6.50.

[Related -Futures Rebound As Liquidity Concerns Ease; Barnes & Noble, Inc. (BKS) Plunges]

[Related -Stocks End Higher On Orders, Housing Data; Netflix (NFLX) Jumps]

Helping boost sales, we believe, are the successful "two guys" television commercials, featuring a pair of dufuses who sit in a car at a drive-in and wax silly over Sonic's new menu choices, including Sonic's foray into the breakfast day part.

Sonic reports fiscal first quarter results after the market close on Jan. 3.  Analysts expect earnings per share of $0.11 versus $0.09 in the year-ago period.  Key to our continued bullishness will be evidence that margin expansion is intact.  To that end, Sonic has been closing underperforming units and opening smaller buildings to wring further efficiencies.

Risks include stiff competition in the fast-food sector and waning consumer confidence if the economy revisits recession absent a deal in Washington to avert the fiscal cliff.  Our view is Sonic's menu matches the competition and that the economic expansion and employment gains continue.

The $593-million market cap Sonic Corp. operates and franchises a chain of quick-service drive-in restaurants in the United States. As of August 31, 2012, the company operated 409 company owned drive-Ins and 3,147 franchise drive-Ins in 43 states. It also leases signs and real estate. The company was founded in 1953 and is headquartered in Oklahoma City.

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