Sonic's Drive-In Charm Continues to Shine

Throwback-style drive-in Sonic (NASDAQ: SONC  ) delighted investors this week by reporting better-than-expected earnings and encouraging forecasts going forward. The fast-food business, which is expanding aggressively on both U.S. coasts, is seeing more traffic with the bonus of well-managed costs. As a result, all sales figures rose attractively and sent the stock up nearly 5% in Tuesday's trading. The question for investors now is whether the company's forward earnings ratio of more than 20 times is a fair price to pay for the expected growth. Let's take a closer look at earnings to look for clues.

Earnings recap
In the company's fiscal 2014 first quarter, Sonic hauled in $126.6 million in revenue -- roughly half a million dollars more than the prior year. While the top-line sales gain wasn't much, net income of $8.2 million showed a substantial improvement over 2013's $6.1 million. Driving the gains was a mixture of both same-store sales -- up more than 2% for the quarter -- and new stores.

On the same-store sales front, franchised drive-ins led the pack with 2.3% growth, while the company-owned stores trailed slightly at 1.9%. The company's focus remains on franchised stores, as evidenced by the seven new franchises opened in the quarter versus just one in the year-ago quarter.

Looking ahead, things are even better. Management is targeting around 15% growth in EPS throughout fiscal 2014, again driven by new-store growth and same-store sales performance. Company drive-ins should see their sales improve as Sonic is installing new point-of-sale and point-of-purchase systems. Margins should also be boosted in the range of 75 to 100 basis points.

Sonic is looking to earn $15 million to $25 million in free cash flow for the full year.

Goin' to California
The story for investors is the company's ambitious franchise growth prospects in California, complemented by a smaller effort in New York.

A new franchise agreement with one of its existing partners will bring 10 new stores to California over the next seven years. This is just one small part of an overall effort to hit 300 stores in the state by 2020.

While Sonic already has a large footprint -- more than 3,500 stores nationally -- it is relatively underrepresented in California. Given the state's love for all things drive-thru and the restaurant's unique menu (part of Sonic's value proposition is tremendous beverage offerings), the concept plays well to this West Coast crowd.

Too much?
At more than 20 times earnings, the stock's no bargain, but that might be OK in this instance. Franchise businesses are incredibly desirable. They are capital-light, free-cash-heavy businesses.

Sonic trades at a decent premium to other fast food stocks, such as McDonald's at 16.5 times earnings, but isn't as rich as others, like Burger King Worldwide's 23.5 times earnings. Sonic deserves a richer valuation than McDonald's as its growth prospects warrant it, and its discount to Burger King, also pushing high-growth tactics, is compelling.

Investors charmed by the roller-skating carhops and flowing cash should take a closer look at Sonic.

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