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Sonic Has a Lot to Prove on Jan. 4

By Demitri Kalogeropoulos - Dec 31, 2017 at 11:26AM

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Previewing the drive-in chain's fiscal first-quarter earnings report.

Investors have been cautious about Sonic (SONC) stock lately. Weak customer traffic trends are pressuring sales and profits, and competition is rising not just from industry rivals like McDonald's, but also from new threats including convenience and grocery stores.

The drive-in chain just closed a fiscal year that included its first revenue decline at existing locations since 2010. That stumble puts more pressure than usual on Sonic to show operating improvements when it releases its first-quarter report after the market closes on Thursday, Jan. 4.

A man taking a bite from a burger.

Image source: Getty Images.

Let's take a closer look at what investors can expect to see in the announcement this week.

Aiming for a sales rebound

A lot of factors contributed to Sonic's posting a disappointing 3.3% drop in comparable-store sales in fiscal 2017. Some of these issues, including hurricane weather and aggressive price cuts by the competition, were outside of the restaurant chain's control. But Sonic made things harder on itself by releasing a summer promotion lineup that failed to spark repeat customer visits. Instead, guest traffic fell by more than 3% last quarter, compared to a 2.1% increase at McDonald's. 

Sonic investors will be looking for solid improvements to those growth figures. In fact, CEO Cliff Hudson and his executive team told investors in early October that the new fiscal year should benefit from well-received promotions like the Carhop Classic value meal that includes a burger and onion rings, but no drink, for $2.99. "Unlike large bundle offers," Hudson explained, "these types of promotions highlight our differentiated products," he said in a conference call with investors. Thus, these offers tend to support customer loyalty rather than generating a short-term jump in customer traffic. 

Hudson and his team said the marketing shift has led to an encouraging start to the new fiscal year, with sales trends improving by 2 percentage points. That rebound gave Sonic the confidence to forecast (barely) positive comps in fiscal 2018, but we'll find out on Thursday whether the positive momentum held up enough to leave its growth prediction unchanged at 1%.

Capital returns

Sonic's initial earnings outlook for the year called for profits to rise by between 5% and 10%, and that target might edge higher or lower this week, depending on management's latest reading on the industry. As usual, shareholders can count on those gains being supplemented by direct cash returns in the form of dividend payments and stock repurchase spending. Sonic spent $24 million on dividend payments last year, or a bit less than half of free cash flow. It allocated far more, $173 million, on buying back its shares, thanks in part to the funds management raised by selling off corporate locations to franchisees.

Hudson and his team might have more to say about capital returns than usual, given that Sonic recently became the target of an activist investor. Southeastern Asset Management said in early December that it has accumulated 16% of the chain's outstanding shares, in fact, and hopes that aggressive stake will open an avenue for dialog with management about, among other things, the "pace of share repurchases." 

Assuming no dramatic change to Sonic's operating or financial strategy, investors should look for the company to prioritize free cash flow in 2018, its first full fiscal year after transitioning to an almost entirely franchised operating model. That shift will drive higher profitability even in a weak sales environment, but investors aren't likely to celebrate rising earnings unless they come paired with improving comps trends.

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