On Tuesday, shares of Sonic Corp. (NASDAQ: SONC) crashed 10% after the company released weaker-than-expected fiscal third-quarter earnings. In addition, investors were concerned when the company stated it would open fewer franchised restaurants than initially anticipated.
Sonic’s report came as a big surprise, because it was performing very well so far this year. Sonic grew comparable restaurant sales – which measures sales at restaurants open at least one year – by 11% last quarter. The stock had reflected its success, as shares were up 25% year-to-date heading into its earnings report.
Now, investors seem to be questioning the bullish thesis behind Sonic. However, here’s why the panic selling was misguided.
Sonic is a valuable concept because of its uniqueness. It’s the nation’s largest drive-in restaurant chain and is an innovator within its industry, with signature products like Master Blast Real Ice Cream treats that break the mold of the traditional burger-and-fries offerings.
Investors sold the fast-food stock because Sonic’s comparable sales clocked in at 6.1% last quarter, only slightly more than half the growth rate from the previous quarter. However, it’s important to remember that 6% comparable-restaurant growth is still a very strong number. Other chains would kill to have that kind of same-restaurant growth. Consider that McDonald’s (NYSE: MCD) global comparable sales declined 2.3% last quarter.
Moreover, Sonic grew year-over-year earnings per share by 26% last quarter. This is a very strong performance in a difficult environment.
Clearly, Sonic is still resonating with customers. Its growth tapered off somewhat last quarter, but that was due in large part to the weather. The brutally cold winter weather not only kept customers at home, but also delayed remodeling and relocation efforts.
Because of this, the company was forced to reduce the number of planned new restaurant openings this year. Sonic now envisions about 22-27 new franchised restaurants opening this quarter, a meaningful decrease from prior expectations. The decline would result in Sonic’s full-year new restaurant openings reaching 47 at a maximum, which would miss management’s previously stated goal of 50-60 new franchise restaurants.
Again, I think that investors selling the stock based on this concern are short-sighted. Sonic will still expand its restaurant footprint, which is in itself a sign of strength. McDonald’s recently announced it would close more restaurants than it opens this year in the United States, so it’s important to remember context.
The harsh winter weather held Sonic’s growth back last quarter, but going forward, it should see a snap-back. Management’s forecast still calls for mid-single-digit same-restaurant sales growth for the full fiscal year, as well as 27%-29% earnings growth this year.
The more legitimate reason for Sonic selling off would appear to be its valuation. Its stock is aggressively priced relative to both the broader market and its own industry. For example, prior to the earnings release, Sonic shares traded for 35 times trailing EPS.
This was significantly above the S&P 500 index, which trades closer to 20 times earnings. And Sonic is also more aggressively valued than many of its competitors in its peer group. McDonald’s trades for just 17 times EPS.
But premium companies typically command premium valuations. Given Sonic’s growth trajectory, it can easily grow into its valuation over time. And now that the fast-food stock sold off 10% after earnings, its valuation is already more modest. The stock now trades for a much more comfortable 30 times earnings.
Sonic also provides a 1.2% dividend yield and offers a nice mix of income and growth. Now that the weather is finally getting warmer, Sonic’s growth should heat up as well over the back half of the year.
DISCLOSURE: Bob Ciura personally owns shares of McDonald’s (NYSE: MCD).
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