After Another Solid Quarter, Is Sonic Worth Betting On?

It has been tough times in the fast-food patch lately. Operators generally struggle with declining customer volumes and per-store sales, epitomized by the struggles of industry bellwether McDonald's (NYSE: MCD  ) . Amid the gloom, though, there are pockets of strength, like drive-in kingpin Sonic (NASDAQ: SONC  ) , which posted positive comparable-store sales in 2013. 

The company has continued its winning ways in 2014. It recently reported positive comps and better-than-expected results for its latest fiscal quarter, a performance that led to a subsequent pop in its share price. On the downside, Sonic's performance anecdotally seems to be a function of higher prices, rather than traffic increases, as better burger outfits like Red Robin Gourmet Burgers (NASDAQ: RRGB  ) continue to win over customers looking for better quality. So, is Sonic a good bet at current prices?

What's the value?
Sonic has spent the past few years retrenching, focused on improving its menu offerings and its overall marketing message. It's a strategy that has produced tangible benefits for the company, including the receipt of a top ranking for the quick-serve restaurant, or QSR, burger category in the latest Temkin Experience Ratings Report. 

Sonic has also been rolling out a smaller-store prototype that lowers operating costs for its franchisees, enabling them to earn greater returns on capital and ultimately encouraging them to open new stores. The positive inertia from its initiatives has led the company to believe that it can grow its store base once again; management's current long-term plans call for an addition of roughly 1,000 stores to its existing store base of approximately 3,500.

In fiscal year 2014, Sonic has posted generally favorable results, as evidenced by a higher comparable-store sales performance that benefited from new product introductions, like its popcorn and grilled chicken offerings. While the company reported flat year-over-year revenue growth, due to a slight reduction in its overall store base, it took advantage of lower relative commodity and labor costs to generate higher operating profitability. The net result for Sonic was significantly better operating cash flow, providing the fuel to fund its drive to fill out its store base around the country, especially in smaller geographies.

Fighting the good fight
Of course, Sonic has a decidedly uphill battle in its quest to manufacture better top-line growth, given the anecdotal travails of the fast-food industry in attracting greater legions of customers. Case in point is industry bellwether McDonald's: It continues to see its customer volumes shrink, despite an extensive campaign to reimage its stores and refine its menu offerings with healthier fare, like McWraps and egg white breakfast sandwiches.

In its latest fiscal year, McDonald's posted disappointing results. It reported marginal increases in both revenue and operating income that failed to meet the company's long-term goals of 3% to 5% systemwide sales growth and 6% to 7% operating income growth. More important, the company reported a 2% global decline in customer traffic, indicating that its store and menu overhaul programs have failed to increase the velocity with which its customers frequent the Golden Arches. 

Naturally, the report did have a few bright spots, including growth in emerging markets like China and Russia. But McDonald's performance on the domestic front would indicate that 2014 may be another tough year in the U.S. for the company and its fast-food competitors, including Sonic.

A better way to go
Given the trends, investors looking to mine gold in the burger business should probably have their eye on competitors that are well positioned to capture their share of the rising tide of customers looking for casual-dining food quality at fast-food prices, like Red Robin Gourmet Burgers. Unlike McDonald's, Red Robin was successful at attracting more customers to its stores in 2013: It reported a 4% increase in comparable-store sales, thanks to its innovative lineup of better burgers and its ability to lure customers with its growing roster of Mad Mixology alcoholic beverages. 

Combined with much-needed commodity-price relief, the higher customer volumes led to higher adjusted profitability for the company during the period. This helped to power its network expansion activities, including a presence in the growing fast-casual restaurant segment through its Burger Works brand.

The bottom line
Sonic's share price has been running hot, up more than 50% over the past 12 months, thanks to a relatively strong comparable-store sales performance and hopes for a new era of growth. However, given the company's P/E multiple of 29, far above its multiyear growth trajectory in sales and operating profit, investors would be wise to stick with the company's tasty food and shakes, not its shares.

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