Professional Documents
Culture Documents
Page 1 of 10
Accounting Issues
= In 2008, there were 684 partner drive-ins. Sonic had a 65% ownership interested in these partner-drive-ins. The 35%
non-controlling interest was composed of $5,220,000 interest, as shown above. As a result of this increased stockholders’
equity, various accounting ratios will be impacted, such as a decrease to ROE.
Financial Analysis
Sonic has positive cash flow from operations (CFO) to either distribute to debt and equity holders or reinvest in the
business. There is a gap in 2008 between CFO and Net Income of $33,543,000. However, it is only 4% of total assets so
it does not raise a red flag. The difference is mostly attributable to the deprecation add back when calculating CFO. For
2008, Sonic has Free Cash Flow (FCF) to common equity of $16,384,000 and FCF to all investors of $929,000. Both of
these numbers are significantly lower than Sonic’s competitors. For example, Jack in the Box (mkt. cap 1.4B) has FCF
to investors of $4,082,000 which is more than 4 times as large as Sonic (mkt. cap 584M). This suggests that Sonic is
using its FCF’s to grow the business. Also, capital expenditures in 2008 were $106,905,000 while Deprecation for 2008
was $60,319,000 which also suggests Sonic is growing its capital base. This is in line with Management’s Discussion
and Analysis where they state their plans to open new franchise stores.
Earnings Quality
The average of Operating Accruals/Net Operating Assets between 2006-2008 for Sonic was 12%, which raises a red flag
in the eVal software. Compared to Sonic’s competitors, Burger King has 9.2% and Jack in the Box has 11.5%.
However, when looking closer at the Sonic financial statements, the majority of the accruals comes from non-current
operating accruals, specifically, expensing the depreciation of capital expenditures. Sonic’s earnings quality is therefore
good since a small percentage of the accruals are associated with receivables and other current asset accounts.
Page 2 of 10
Sonic bought back a significant amount of shares outstanding through a tender offer in 2007, which actually made their
shareholder equity negative. Due to this, Return on Equity and the Sustainable Growth Rate are not applicable ratios.
The applicable ratio to assess the future profitability of projects is Return on Net Operating Assets (RNOA) which is a
measure of the firm’s operating performance. Sonic’s average RNOA over the past 4 years is 15.13%. Because Sonic
has no common equity outstanding, the cost of debt will be used as the hurdle rate for projects. Currently, Sonic has
$573.3M in outstanding debt at a fixed interest rate of 5.7% and $185M in variable note debt outstanding at 3.7% which
gives a weighted average cost of debt of 5.21%. The spread between RNOA and their cost of debt shows that future
expansion projects will be profitable. Also, the spread between RNOA and NBC for Sonic is 9.3% in 2008, which also
shows that future projects will have a positive return as well.
Sonic’s Gross Margin has been consistently around 78% for the past 4 years. Comparatively, for 2008 Gross Margins for
their competitors were: BKC 34.8%, CKR 19.7%, and JACK 17.2%. Sonic’s high gross margin is attributable to their
low Cost of Goods Sold because they receive royalty payments and franchise fees from their franchisees but do not
record any associated expenses with the franchisee’s operations. Sonic’s growth plans state that they are looking to
transition their partnership stores to franchises, which will reduce their COGS, and keep their gross margin high. Not
only does Sonic have high gross margins but they also have a high EBIT margin that has been consistently around 21%
for the past 4 years. Their EBIT margins in 2008 were higher than any of their competitors. Sonic’s ability to turn gross
profits into EBIT gives the firm high marks on operating performance.
Turnover Analysis
Sonic has an inventory holding period of 9.249 for 2008, which is the highest between its competitors. In comparison,
Burger King has an inventory holding period of 3.536. Since the inventory is mostly perishable goods, a very low
holding period is a great indicator of quality and efficiency of operations. Sonic’s higher than normal holding period is
cause for concern because it negatively reflects the efficiency of operations as well as the quality of their product.
However, as stated above Sonic is still able to produce high gross margins from their products so the quality of their food
must not be a major issue with the end consumer.
In 2007, Sonic significantly changed their capital structure by issuing $591,037,000 in debt and buying back
$562,687,000 in common stock outstanding. Their CFO to Debt ratio sits at 12.1% in 2008, which is fairly low and
reflects the significant amount of debt financing Sonic took on in 2007. Sonic’s current ratio is 0.883 which is cause for
some concern considering that they now have large fixed interest payments. However, their EBIT interest coverage ratio
is 3.326, which shows that despite their high amount of debt outstanding, their EBIT can still cover their interest
payments. To compare to Sonic’s competitors, BKC’s EBIT/Interest Coverage ratio is 5.284 and JACK’s is 7.691. The
higher ratios show that Sonic has taken on more debt proportionally than its competitors, especially given that Sonic’s
EBIT margins are well above its competitors. Sonic’s average implied default probability is only 4.5% which is mixed
between their competitors probabilities, and is relatively low. Overall the large debt financing seems to be appropriate
given their high RNOA and low default probability.
Forecasting
Sonic has seen historical success with increasing sales and profit margins. However, the recent economic downturn has
had a large impact on many industries, including the restaurant and food business. As a result, Sonic expects to produce
its first negative same-store sales growth in 22 years. Our financial forecast includes an analysis of several different
account balances, which are broken into expected, worst, and best case scenarios. The combination of these variable
effects produced a “low to high” range for the appropriate price to be attributed to a share of Sonic common stock. In
other words, the combination of all the worst scenarios would result in the lowest possible share prices. On the contrary,
an evaluation of all the best possible scenarios would produce the highest current stock price. The variables, their
respective values, and reasoning are presented below:
Page 3 of 10
Expected Worst Case Best Case
Forecasting Variables 2009 2010 2009 2010 2009 2010
Sales -2.5% -1.8% -4.5% -2.6% -1.0% -0.4%
COGS/Sales 23.0% 22.9% 25.0% 25.3% 22.1% 22.1%
SG&A/Sales 52.5% 52.3% 55.0% 55.3% 51.0% 51.0%
Net Ending PPE/Sales 75.0% 74.8% 77.0% 77.6% 73.0% 73.0%
Sales
2008 revenue totaled $804.7 M, composed of $671.2M from Partnership stores and $133.6M from Franchise stores.
Sonic’s total revenue is predominantly composed of revenue from Partnership stores because only royalty payments and
fees are recorded as revenue from Sonic Franchise stores. During the first and second quarters of 2009, company-wide
revenue per store decreased 3.6%. Based on this trend, we forecast revenue per store decrease of the same amount (3.6%)
for the second half of 2009. Store expansion has slowed, and therefore we project only 25 new stores to open in the
second half of 2009. Based on the above facts and analytics performed, 2009 total revenue is projected to be $784.8 M.
In the worst case scenario, we looked at analysts’ current outlook of Sonics annual performance. Due to the economic
conditions, it is very likely that Sonic will experience negative growth in sales. As a result, some estimates are expecting
sales growth as poor as -4.5% and -2.6% for Sonic in FY2009 and FY2010, respectively.
Cost of goods sold (COGS) will be affected by various factors in the upcoming years. As a part of their ongoing
operations, Sonic’s partner stores purchase large volumes of different commodities, such as beef, potatoes, chicken, and
dairy products. As noted in their latest 10K report, Sonic does not rely upon hedging activities to mitigate their potential
losses as a result of changing commodity prices. Instead, Sonic relies upon contractual agreements with their vendors
through the use of price floors or caps. However, Sonic has not entered long-term contracts to purchase substantial
amounts of commodities; therefore, Sonic is still vulnerable to increasing commodity prices. An increase in the
commodity prices coupled with the new value meal food options (menu items with reduced sales prices) will result in an
increase in the COGS as a percentage of sales figure. Additionally, increased labor costs, particularly in regards to the
increase in the federal minimum wage, will increase the ratio of cost of goods sold to the amount of sales. As a part of
our sensitivity analysis, we estimate that the expected COGS to sales ratio to be 23%, the worst-case scenario will be
ratio will be 25%, and the best-case scenario will result in a COGS to sales ratio of 22%.
Towards the beginning of Sonic’s fiscal year 2009, Sonic introduced various value meal food options to their existing
menu. To provide Sonic restaurants with the ability to sell the value meal items Sonic will incur more costs, namely
Page 4 of 10
costs associated with marketing and promotions, to successfully implement the new value menu items. While these
value meal food options will be comprised of lower margin food options, they will be helpful in attracting more
customers seeking budget-friendly dining options. But, the additional costs will be necessary to alert existing customers
and potential customers of the new offerings. Additionally, positive sales growth in Sonic restaurants will depend upon
the ability of Sonic to drive customers away from the new value menu meal options towards the pricier food options
(items offering a greater profit margin) using marketing and promotional campaigns. Furthermore, Sonic will attempt
to transition from a regional brand to a national brand. This will likely require additional SG&A costs to make this
transition come to fruition. We estimate the effect of these changes will result in a higher level of SG&A costs. Using
data from previous years, we estimate the expected value of the SG&A costs to be 52.5% of sales, a modest increase
from fiscal year 2008. To conduct out sensitivity analysis we have created a range of SGA per sales using a figure of
55% for the worst-case scenario and 51% for the best case scenario. Once these figures have been input into the eVal
model for fiscal year 2009, the eVal model is allowed to create a slightly decreasing trend for SG&A costs relative to
sales since fixed components of SG&A costs will provide economies of scale.
Capital Expenditures
For fiscal year 2009 Sonic plans to invest in many new restaurants. As a result of their expansion efforts, Sonic plans to
incur capital expenditures in the amount of $60 to $70 million. Using data from previous years, an average depreciation
rate was calculated. Values of $60 million, $65 million, and $70 million, were added to the ending PP&E balance for
2008, and an average depreciation rate was used to calculate the estimated ending balance of PP&E for fiscal year 2009.
Using the calculated PP&E balance as a basis, the 2009 ratio for ending PP&E/sales was adjusted to arrive at the
expected amount of PP&E for 2009 shown on the forecasted balance sheet. Using the three values of capital
expenditures listed above the following values for ending PP&E/sales: 74% for $60 million in capital expenditures, 75%
for $65 million, and 75.6% for $70 million. Using these figures, an expected value for ending PP&E/sales is estimated to
be 75%. For our sensitivity analysis, we utilized a ratio of 77% as a worst case scenario, and 73% for a best case
scenario.
2007 2008
PP&E 529993 586245
Depreciation -45103 -50653
Depreciation Rate 0.0851 0.0864
Capital Expenditures (CAPX) PP&E after CAPX Ending PP&E Ending PP&E/Sales
60000 646245 590828 74.00%
65000 651245 595400 75.00%
70000 656245 599971 75.60%
Refranchising
Sonic Corp is currently operating under a combination of franchises and partner stores which are 80 and 20 percent of the
business, respectively. Recently, The Company began to undergo a procedure to move away from their partner
restaurant operations and focus more on franchising their brand name. As a result, Sonic is likely to give up a large
amount of their sales revenue from partner relationships. However, the Cost of Goods Sold related to these restaurants
will also decrease significantly. Though it is unclear how Sonic’s reorganization will play out, it is apparent that the firm
is attempting to become dependent on its franchising operations. Since the ability and effects of such a process are very
suspect and difficult to predict, we have omitted the refranchising variables from our financial forecasting and valuation.
Page 5 of 10
Valuation
Discount Rate
Beta
The cost of equity was calculated using the Capital Asset Pricing Model Sonic 1.35
(CAPM). We used a risk-free rate of 5.5% and a market premium of 6%. An BK 1.00
average of industry comparables was calculated in order to arrive at an CKE Restaurants 1.30
appropriate value of beta for our analysis.
Jack in the Box 1.00
Average 1.1625
As seen in the table above, Sonic has historically been a risky stock compared to the market and other fast-food chains.
We feel that their expansion and implementation of more competitively priced food will eventually result in a less risky
security. Using the aforementioned information, the CAPM produced a cost of equity of approximately 12.5%.
In order to arrive at a range of target stock prices, we inserted our forecasted scenarios into the eVal software and valued
the stock based on the Discounted Cash Flow Method. The results of the computations are presented below:
Our expected target price of $10.58 is only slightly lower than Sonic’s current stock price of $10.76. Furthermore, the
best and worst case scenarios provide a relatively tight range of possible share prices. This further supports the validity
of the current market perception of Sonic. Though our evaluation shows that the company is slightly overvalued, the
volatility of today’s market does not allow us to apply a sell rating to Sonic Corp. stock.
Many other analysts currently evaluate the price and performance of Sonic in a similar manner. Recently, Citi
downgraded the stock from “neutral” to “underperform,” which is comparable to our understanding that the price of
Sonic is overvalued. Furthermore, analysts currently forecast an EPS of $0.77 for FY 2009. This is aligned with our
estimate of -2.5% sales growth, which produces a 2009 projected EPS of $0.73. Any discrepancies seem to develop
from the expectations of sales growth and operating expenses. Other analysts are predicting a higher decrease (-4.5%) in
Page 6 of 10
revenue with less increase in COGS and SG&A. However, these differences are very minor and do not seem to have any
material effect on the valuation.
Sources
Basham, Mark. “Standard & Poor’s Industry Report: Restaurants.” March 19, 2009.
Forbes.com. “Sonic traffic improving, sales poised to rally.” March 24, 2009.
<http://www.forbes.com/feeds/ap/2009/03/24/ap6204549.html>.
Page 7 of 10
Supporting Exhibits
Financial Analysis
Page 8 of 10
Cross-Sectional Analysis
Fiscal Year 2008 (in thousands)
Sonic (SONC) Burger King (BKC) CKE Restaurants (CKR) Jack in the Box (JACK)
Cash from operations 93,862.00 223,000.00 40,574.00 17,210.00
Cash from Investing (102,721.00) (170,000.00) 11,438.00 6,419.00
Cash from Financing 29,113.00 (57,000.00) (50,699.00) 8,553.00
Cash Flow Analysis Net Change in Cash 20,254.00 (4,000.00) 1,313.00 32,182.00
Ending Cash Balance 59,200.00 166,000.00 19,993.00 47,884.00
FCF to common equity 16,384.00 61,000.00 263,478.00 71,753.00
FCF to all investors 929.00 100,447.00 68,893.00 4,082.00
Current Op. Accruals/NOA 4.30% -1.10% 0.20% 11.70%
Earnings Quality Non-Current Op. Accruals/NOA 7.20% 10.30% -4.10% 0.20%
Operating Accruals/NOA 11.40% 9.20% -3.90% 11.50%
Sales 4.40% 9.90% -3.40% -11.70%
Assets 10.30% 6.80% -0.30% 8.40%
Annual Growth Rates Free Cash Flow to Investors N/A -40.70% -12.40% -98.60%
Sustainable Growth Rate -70.60% 20.00% 6.70% 27.40%
ROE -70.60% 24.30% 11.90% 27.40%
Profitability ROE before non-recurring -85.20% 23.80% 12.40% 27.00%
Return on Net Operating Assets 13.30% 13.50% 9.20% 15.00%
Gross Margin 77.90% 34.80% 19.70% 17.20%
Margin Analysis EBIT Margin 20.60% 14.40% 5.80% 8.50%
Avg. Inventory Holding Period 9.249 3.536 7.107 7.998
Turnover Analysis Net Operating Asset Turnover 1.17 1.423 2.805 2.785
Debt to Equity Ratio (12.43) 1.121 2.699 1.134
Long Term Capital Structure FFO to Total Debt 0.16 0.219 0.146 0.241
CFO to Total Debt 0.12 0.236 0.142 0.036
Current Ratio 0.883 0.886 0.772 1.109
Liquidity Analysis EBIT interest Coverage 3.326 5.284 2.674 7.691
Credit Risk Average Implied Default Probability 4.50% 3.50% 5.30% 4.60%
Page 9 of 10
2009 Forecasted 2009 Forecasted 2009 Forecasted
% of the year stores Franchise 2009 Forecasted Total Partnership-Store Partnership-Store
2009 Sales/Store Analysis Franchise Stores Partnership Stores will generate revenue Sales/Store/Year Franchise Revenue Sales/Store/Year Revenue
Sales Growth
Number of stores on Day 1 of 2009 2791 684 (12/12) $46,131.77 $128,753,768.00 $945,891.18 $646,989,564.00
2009 Q1 Net number of new stores 25 5 (12/12) $46,131.77 $1,153,294.23 $945,891.18 $4,729,455.88
2009 Q2 Net number of new stores 19 2 (9/12) $46,131.77 $657,377.71 $945,891.18 $1,418,836.76
2009 Q3 FORCASTED Net number of new stores 14 1 (6/12) $46,131.77 $322,922.38 $945,891.18 $472,945.59
2009 Q4 FORCASTED Net number of new stores 9 1 (3/12) $46,131.77 $103,796.48 $945,891.18 $236,472.79
$130,991,158.81 $653,847,275.02
Page 10 of 10