Sonic (SONC) is one of America's few remaining chains of drive-in restaurants, where customers park in a booth, order through a speaker system, and then dine in the car after a carhop delivers the meal. As popular as this system has been in the past, Sonic is struggling to bring recession-weary customers back to its booths.
During its earnings call after the market closed on June 21, the company reported an underwhelming earnings figure of 18 cents a share for the third quarter. Wall Street analysts had estimated earnings between 19 and 21 cents a share. Worse, the profit figure included a one-time gain of three cents a share from a tax benefit.
Excluding the gain and other special items, Sonic's net income dropped 37.5% from a year earlier. Management cited the combination of debt reduction and disappointing same-store sales as the reason for the decline. (The transcript of the earnings call has more details.)
What Do These Numbers Mean for Investors?
Lynne Collier, the managing director of Restaurant Research at Sterne Agee, sees this regression as a "serious setback." She notes that investors were looking for this quarter to mark the turnaround for Sonic and a return to financial growth. The company was to use this period as a springboard for the next quarter, which is typically its strongest one. Now there is doubt as to whether sales can recover and Sonic can end its fiscal year on a good note.
Compounding the problem is Sonic's financial leverage. In an attempt to strengthen its balance sheet, the company has been paying off some of its debt. Usually, reducing liabilities is beneficial to a company, but it can be painful in the short run since cash used to pay off debt isn't available for other purposes such as expansion, or marketing.
Weakness in Sonic's current fourth quarter, which runs from June 1 to Aug. 31, implies that the coming colder months will see an even worse dip in activity at the start of the next fiscal year.
While the booth and drive-through system is part of the company's image, it makes for volatile sales. The setup depresses sales during the winter, as people are less likely to want to sit in their cars and eat in bad weather, especially as gasoline to run their heaters gets more expensive.
This isn't the only issue that Sonic must address. One of its historical selling points, original drinks, is being tested. Calling itself the "Ultimate Drink Stop," Sonic has prided itself in having an unrivaled selection of exclusive drinks. Now, other players in the restaurant field are challenging this claim by rapidly expanding their drink offerings to compete with Sonic.
Most of the challenges that lie ahead of Sonic are endemic to the restaurant business. Competition is cutthroat, and with so many individual businesses fighting over customers, differentiation is difficult -- hence the need for a marketing recharge.
Analysts had complained that the company's marketing strategy was getting somewhat old. Sonic apparently agreed, announcing that Danielle Vona, a former PepsiCo (PEP) vice president, is the new chief marketing officer. She brings to the job a good record at PepsiCo for introducing and promoting new products, including the Propel and Sierra Mist brands plus juice and dairy products, during her 11 years with the company.
If Vona is effective, sales volume should be able to recover from recent troubles. The booth and drive-through business model, in spite of its flaws, is what separates Sonic from every other fast-food restaurant. Retaining that separation and improving the brand's attractiveness can keep existing customers while bringing in new ones.
Sonic has proven its ability to open new locations successfully, and there are countless possibilities for new franchises. In New Jersey, for instance, lines for newly opened Sonic restaurants can stretch for blocks and last past midnight.
The possibility of expansion of both franchises and profitability make Sonic an interesting company to investors, if only a fresh marketing campaign can bring in the customers.
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