Sonic (NASDAQ:SONC) first popped up on my radar last fall. Its stock was trading weakly, but digging a little deeper, I found out that the company was buying up shares like crazy. The stock has paid off nicely since then for savvy buyers, as my Foolish colleague Jim Mueller pointed out -- increasing 14% over the short period.
Things continue to look good for the drive-in eatery. The latest results surpassed analyst expectations with the aid of solid mid-single-digit same-store-sales increase. In an attempt to discover its winning recipe, Bodhi Zappa and Hank Schofield have joined me to take a closer look at Sonic via its latest quarterly earnings conference call.
Jeremy: Bodhi, comps for the third quarter increased 4.3% largely because of the strength of its franchised units. What has been the winning strategy for these sites?
Credit card bonanza
Bodhi: If you ever wondered whether using plastic instead of cash makes you spend more, look no further than the latest figures from Sonic. What's really driving sales is the installation of credit card payment terminals at each drive-in stall. Referred to as PAYS, the program has been wildly successful for the company. Since its inception, credit card transactions went from 8% to 10% of sales to over 25% of sales. And according to management, this figure continues to grow. Additionally, average dollar transaction amounts have risen, as customers spend on average about $7 per transaction with a credit or debit card as opposed to $5 when only using cash.
Hank: It's unfortunate that not all of the units are equipped with the technology. To date, approximately 72% of Sonic sites use PAYS.
Jeremy: But it's expected to be 100% by year-end. The continued expansion should bode well for healthy comps in the quarters to come. Management is projecting 3% to 5% comps growth for the fourth quarter. Through the first three weeks of June, sales were within this range.
Fresh products
Bodhi: Improved credit card access is just one part of the winning strategy. The other ingredient working for Sonic is the introduction of new products. New products tailored with targeted promotions are drawing in customers.
Hank: A $0.99 classic junior banana split, raspberry iced tea, peach iced tea, hot fudge brownie blast, and on and on and on. We get it -- the company likes to change it up by adding new menu items. Doesn't that seem a little gimmicky? I mean, if each time you pull into one of Sonic's stalls you see a new hyped product, is it possible that the inconsistency in the menu could lead to an equal inconsistency in keeping customers?
Jeremy: A stagnant menu is a much greater fear to restaurants. We can look across the board from Ruby Tuesday's (NYSE:RI) and its reinvigorated burger-centric menu to McDonald's (NYSE:MCD) and its constant menu changes to see the positive effects of keeping a fresh offering of products to customers. Sonic is no different. The junior banana split, for instance, is already driving traffic and sales in the month of June.
Hank: New products and accompanying promotions don't come without costs. Media spending for the year is projected to total roughly $145 million -- higher than the $125 million spent last year.
A growth strategy built on franchising
Bodhi: You have to pay to play. Besides, it's working. As management pointed out, the marketing efforts are "raising overall brand awareness" and "attracting new franchisees." Considering that franchising is such a significant part of Sonic's business -- of the 43 drive-ins opened in the third quarter, 37 were franchised -- its expanded marketing campaign seems to be an appropriate use of company resources.
Hank: I'm glad you raised its franchising efforts, because this leads me to one of my concerns raised in the call. Management indicated that rising land costs and rising interest rates are making it more challenging for potential franchise partners to come up with the needed funding for new site development. One has to wonder how long Sonic can continue to expand at this rate, given these pressures.
Bodhi: To address these challenges, Sonic will "add resources" to be "more proactive on the real estate side" and help franchisees in locating suitable sites. Additionally, based on President Scott McLain's response to one analyst question, Sonic will also be helping out more on permitting and other items related to the construction and opening of the drive-ins. Perhaps this is why management is still calling for 600 units to be developed over the next several years.
Foolish bottom line
Jeremy: Rising interest rates and skyrocketing land costs are a problem that every restaurant has to contend with. This certainly bears monitoring in the quarters ahead, but it should not be a reason to stop taking a closer investigation of Sonic. The drive-in operator is benefiting nicely from its PAYS program and from the introduction of fresh menu items. Looking ahead into the fourth quarter, it will also continue to benefit from softer beef and dairy costs, as well as lower packaging expenses. The result of all this is expected to lead to "slightly favorable restaurant margins on a year-over-year basis." Couple profitability improvements with solid top-line performance, and Sonic is offering one more reason to drive in and take a closer look at the company.
Check out our suite of newsletters by taking a 30-day free trial of the newsletter that best fits your investing style.
Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.
