Sonic: Will the Sizzle Fizzle?
Investors have gobbled up the the drive-in burger chain with relish, but a reliance on warm-weather locations could leave a bitter taste Sonic Corp., which bills itself as "America's drive-in," also has a reputation as a company in growth mode. Among other accolades, BusinessWeek named it a hot-growth company in 2002. Not bad for a burger-and-shakes chain that will turn 50 this year.
April 30, 2003
Investors have gobbled up the the drive-in burger chain with relish, but a reliance on warm-weather locations could leave a bitter taste Sonic Corp., which bills itself as "America's drive-in," also has a reputation as a company in growth mode. Among other accolades, BusinessWeek named it a hot-growth company in 2002. Not bad for a burger-and-shakes chain that will turn 50 this year. That makes the Oklahoma City-based outfit two years older than the perceived granddaddy of fast-food franchises, McDonald's, which has shed its mantle as a Wall Street darling in recent years. McDonald's (MCD ) inability to keep delivering strong growth may be an omen for Sonic. After building some 30,000 restaurants around the world, the outfit seems recently to have hit the limits of expansion. Sonic (SONC ) has just 2,600 outlets in the U.S., yet it plans to add another 800 to 1,000 drive-ins over the next five years. In fiscal 2003, it aims to open about 190 more outlets. HIGH PRICE OF SUCCESSSonic's earnings per share have climbed steadily, rising about 20% annually over the last five years. Analysts polled by First Call expect to see that figure rise by 17%, to $1.32, in the fiscal year ending Aug. 31. That kind of earnings growth is considered better than solid for the so-called quick-service restaurant business. However, Sonic's stock price already appears to reflect more than its current success, having soared 50%, to around $27, in the last two years. Compare that to McDonald's shares, which have tumbled about 40%, to $17, in the same period. Restaurant stocks overall have fared better than the broader market in that time, losing just 11%, vs. a 25% decline in the Standard & Poor's 500 stock index. Sonic stock is pricey, analysts say, especially considering how much expansion the purveyor of burgers on "Texas toast" and fried pickles has planned. "It's a well-run company, but it's not going to expand as much as people think," says Dennis Milton, Standard & Poor's restaurant-stock analyst. He points to a better valuation for Sonic's Columbus (Ohio)-based competitor, Wendy's International (WEN ), which trades at $28 per share, or 12.4 times next year's consensus earnings forecast. By contrast, Sonic trades at 17 times earnings. Milton, who figures that Sonic is worth closer to $23 or $24 -- more than 10% below its current level -- rates it avoid. SHRINKING PIE Meanwhile, as Sonic rapidly expands, the burger business is slowly becoming a smaller segment of the eat-and-go restaurant sector, as Americans gradually acquire a taste for healthier food. Sonic has been gaining market share, from 2.9% in 1997 to 4.7% in 2002. The nostalgic appeal of the 1950s-style carhops who deliver made-to-order burgers, chili dogs, and shakes to customers' cars seems to be helping Sonic make headway in the competitive burger business. Yet the risk is that Sonic's niche has its limitations. In the short term, ongoing price wars among the larger burger chains could pose a problem. McDonald's and Burger King have been discounting aggressively with "dollar" menus and other promotions. In a difficult economy, budget-conscious consumers may pass up a meal at Sonic for a discount option down the street. Says Milton: "A certain percentage of people will opt for the cheapest prices."Severe weather can also hurt sales for retailers and restaurants, but Sonic appears more vulnerable since its business is primarily outdoors. In its fiscal second quarter ending Feb. 28, Sonic reported income growth of 12%, to $8 million, on an 11% rise in revenues, to $90.4 million. Sales at restaurants open at least a year, known as "same-store" sales, fell 0.2% because of brutal winter storms in the South. The chain has promised better same-store sales as the weather warms and an 18% rise in earnings per share in the second half of the year. Sonic declined to comment for this article. WARM-WEATHER IDEA Looking at the long term, analysts caution that the restaurant's concept promises only a finite expansion in the U.S. Jonathan Waite, an analyst with Los Angeles-based investment bank McDonald Investments, calls Sonic "the biggest chain you've never heard of." Currently, more than one-third of its stores are in Oklahoma and Texas. "The concept doesn't work all that well outside of warm-weather states," Waite adds. Sonic will be able to add more stores in the Midwest, he says, but "it's not going to be huge growth for them." (Waite, who rates Sonic a buy, doesn't own its shares, and his firm has done no banking with the company.) Just as important, while burger chains have successfully expanded into international markets, the drive-in concept likely won't translate abroad. Consumers in global markets tend to have lower rates of car ownership than U.S. households. "It's not the type of restaurant that you can put anywhere," Milton says of the eateries, which have covered patio seating but no indoor dining areas. By comparison, Wendy's plans to continue the aggressive expansion of its worldwide store base. And it has aims to grow coffee-shop subsidiary Tim Horton's to more than 3,500 units, and Baja Fresh, which sells Mexican fare, to 700 to 800 stores. Still, not everyone thinks Sonic has the odds stacked against it. "There's a quality and freshness perception" that consumers like, says Amy Greene, an analyst at Nashville-based Avondale Partners. She notes that, on average, Sonic patrons visit outlets seven to eight times every month, a reflection of the brand's potent customer loyalty. Greene rates the stock as market outperform and has a price target of $30. (She doesn't own its shares, and her firm has no investment-banking relationship with Sonic.) Clearly, Sonic has found a corner of the fast-food restaurant market that's doing well. But future growth will have its obstacles, and investors may want to ponder the observations of analysts who believe the stock's price isn't an accurate reflections of the challenges down the road.
