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Sonic Corp Stock Analysis

Sonic Corp Stock Analysis

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Published by Josh Bloom

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Published by: Josh Bloom on May 14, 2009
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Johnson & Company, Inc.
RestaurantQuick ServiceAnalysts:
Josh BloomPhil CullenDavid JohnsonRoss PyshCompany UpdateRating: Neutral/HoldPrice: $10.76Price Target: $10.58
Market Data
52-Week Range: $5.78-22.92Market Cap (MM): $584.41Total Shares Out. (MM): 60.56Avg. Daily Vol.: 842,647
Financial Summary
Book Value (MM) ($64,166)Debt (MM) $796,807
USD 2008A 2009E 2010E
Rev. (MM) 804,713 768,770 748,550EBITDA (MM) 216,783 -- --
EPS
Nov 0.15 0.12A --Feb 0.22 0.08A --May 0.28 0.26 --Aug 0.33 0.31 --
FY Aug 0.97 0.77 0.92
April 13, 2009
Sonic Corp (NASDAQ: SONC)
Investment Summary
Sonic has underperformed in the first two quarters of FY2009 due to a tough economic downturn. Nevertheless,we feel that the implementation of a new $1 value meal anda corporate plan to refranchise will help earnings improvein the second half of 2009. As a result, we feel that Sonic’scurrent price is a fairly accurate representation of thecompany’s true economic standing.
Company Profile
Sonic competes in what is called the “drive-in restaurant”industry. Competition includes Burger King, CKERestaurants, and Jack in the Box, among others. Sonic is afranchisor, much like Boston Chicken, which we discussedearlier this semester. 80% of Sonic’s 3,500 restaurants arefranchises and the remaining 20% are classified aspartnership stores. Sonic Corp. is classified as either aminority or majority owner in their partnership restaurants.The company is currently working to increase the numberof franchise restaurants from 80% to 90% and to decreasethe number of partnership stores from 20% to 10%. Itsbusiness strategy includes:1.)
 
Providing a unique drive-up experience2.)
 
Maintaining a strong focus on customer satisfaction3.)
 
Continuing U.S. store expansion4.)
 
Maintaining strong franchisor/franchiseerelationshipsSonic’s business strategy
will
enable it to sustainprofitability. Even amidst the current recession, Sonicrecorded a healthy $8.6 million net income for the mostrecent quarter ended Feb 28, 2009. Sonic’s recentintroduction of their value menu, in combination with theirincreased advertising presence, has enabled them tomaintain strong levels of profitability. We believe thatSonic will continue to succeed in the very competitive fastfood industry because it has a 50+ year proven winningformula that delivers positive profits every year regardlessof the economic climate.
 
 
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BKCCKRJACK200510.60%7.50%7.80%20065.60%-10.00%8.80%20079.10%4.60%5.60%20089.90%-3.40%-11.70%average8.80%-0.33%2.63%
3.70%
Sales Growth Rates
Accounting Issues
Overall, Sonic’s accounting accurately reflects their underlying businessreality. Because of the lack of apparent accounting distortions, we decided toillustrate the affect FASB’s 2009 FAS 160 will have on the presentation of Sonic’s minority interest in net assets. Prior to September 1, 2009, Sonic hasand will continue to present their minority interest in partnership stores on thebalance sheet between liabilities and equities. However, for all statementsthereafter, Sonic will be required to present their non-controlling interests inthe equity section of the balance sheet. If FAS 160 were in effect for the yearended 2008, a reconciliation of Sonic’s equity section would appear like thetable to the right.= 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
Cash flow analysis
Sonic has positive cash flow from operations (CFO) to either distribute to debt and equity holders or reinvest in thebusiness. There is a gap in 2008 between CFO and Net Income of $33,543,000. However, it is only 4% of total assets soit does not raise a red flag. The difference is mostly attributable to the deprecation add back when calculating CFO. For2008, 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 FCFto investors of $4,082,000 which is more than 4 times as large as Sonic (mkt. cap 584M). This suggests that Sonic isusing its FCF’s to grow the business. Also, capital expenditures in 2008 were $106,905,000 while Deprecation for 2008was $60,319,000 which also suggests Sonic is growing its capital base. This is in line with Management’s Discussionand 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 flagin 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-currentoperating accruals, specifically, expensing the depreciation of capital expenditures. Sonic’s earnings quality is thereforegood since a small percentage of the accruals are associated with receivables and other current asset accounts.
Growth Rates, Profitability and Margins
 Sonic has a 4 year average sales growth rate of 10.73%.Comparatively, the average sales growth rate of Burger King,CKE Restaurants, and JACK in the Box’s 4 year average growthrates is 3.7%. This implies that Sonic’s sales have been growingat a faster pace than the industry average sales growth rates in thepast 4 years.
 
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Sonic bought back a significant amount of shares outstanding through a tender offer in 2007, which actually made theirshareholder 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 ameasure of the firm’s operating performance. Sonic’s average RNOA over the past 4 years is 15.13%. Because Sonichas 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% whichgives a weighted average cost of debt of 5.21%. The spread between RNOA and their cost of debt shows that futureexpansion projects will be profitable. Also, the spread between RNOA and NBC for Sonic is 9.3% in 2008, which alsoshows 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 fortheir competitors were: BKC 34.8%, CKR 19.7%, and JACK 17.2%. Sonic’s high gross margin is attributable to theirlow Cost of Goods Sold because they receive royalty payments and franchise fees from their franchisees but do notrecord any associated expenses with the franchisee’s operations. Sonic’s growth plans state that they are looking totransition their partnership stores to franchises, which will reduce their COGS, and keep their gross margin high. Notonly 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 grossprofits 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 lowholding period is a great indicator of quality and efficiency of operations. Sonic’s higher than normal holding period iscause 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 foodmust not be a major issue with the end consumer.
Capital Structure and Risk Analysis
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 andreflects the significant amount of debt financing Sonic took on in 2007. Sonic’s current ratio is 0.883 which is cause forsome concern considering that they now have large fixed interest payments. However, their EBIT interest coverage ratiois 3.326, which shows that despite their high amount of debt outstanding, their EBIT can still cover their interestpayments. To compare to Sonic’s competitors, BKC’s EBIT/Interest Coverage ratio is 5.284 and JACK’s is 7.691. Thehigher ratios show that Sonic has taken on more debt proportionally than its competitors, especially given that Sonic’sEBIT margins are well above its competitors. Sonic’s average implied default probability is only 4.5% which is mixedbetween their competitors probabilities, and is relatively low. Overall the large debt financing seems to be appropriategiven their high RNOA and low default probability.
Forecasting
Sonic has seen historical success with increasing sales and profit margins. However, the recent economic downturn hashad a large impact on many industries, including the restaurant and food business. As a result, Sonic expects to produceits first negative same-store sales growth in 22 years. Our financial forecast includes an analysis of several differentaccount balances, which are broken into expected, worst, and best case scenarios. The combination of these variableeffects produced a “low to high” range for the appropriate price to be attributed to a share of Sonic common stock. Inother 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, theirrespective values, and reasoning are presented below:

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