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Sonic Corp: Undervalued Franchise Restaurant With Multiple Catalysts

Summary

Sonic’s recent announcement to move from 89% franchised to 95% franchised system is a major catalyst for the stock.

Sonic's history of success in product innovation and marketing highlight the company's ability to sustainability grow individual store sales.

Sonic returns a high portion of its cash flow to shareholders through dividends and buybacks as the franchise model requires very low capital to perpetuate.

Sonic shares in a base case are worth $46 (64% Upside from ~$28).

Sonic Corp (NASDAQ:SONC) is franchise Drive-In restaurant chain that dominates in more rural areas of the United States. The company offers Burgers, Hot Dogs, Fries, Breakfast, and Shakes in a Drive- In style format. Sonic has had success in the last few years with a strong marketing campaign which continues to highlight their product innovation. The "Sonic Guys" or "Two Guys" commercials have been a real hit and been a very popular ad campaign for the company for the last 5 years.

Investment Thesis Summary

  • Sonic's recent announcement to move from 89% franchised to 95% franchised system (known as a "refranchising effort" ) will generate roughly $150 to $200m in additional cash that will be used for share buybacks (11%-15% of shares outstanding). This figure is based on my estimates which I highlight below.
  • Sonic uses a franchise model which has highly stable revenues with high gross margins that are very attractive over the long term (Capital Light Model). Average Royalty rate is currently 4.04% and will gradually increase to 5% as franchise agreements turn over.
  • Sonic's store footprint has remained flat over the last 4 years largely due to the elimination of lower profitable sites and additions of more desirable sites. Average Sales per site has increased at a 3 yr CAGR of 5.5% during this time. Management believes they are now in a position to have net site additions to their store footprint of ~30 sites per year going forward on a sustainable basis.
  • Sonic's marketing and menu innovation has been very successful over the last 5 years and has driven SSS as high as 11.5% in Q2 2015 and has averaged 4.2%. Sonic's Point of Personalized Service (POPS) Intuitive is modernizing their store offering and will drive SSS increases over the next few years.
  • Sonic returns a high portion of its cash flow to shareholders through dividends and buybacks as the franchise model requires very low capital to perpetuate. At the current share price the company anticipates it will buy back roughly 11% of shares in the next 12 months excluding the refranchising effort. Companies with this high of share buybacks are extremely attractive as the share prices fall further as the share count retired via buyback increases as the share price falls.

Why does this opportunity exist?

· Sonic's recent same store sales figures have declined compared to the previous 2 years (2.0% in Q3 2016 vs 6.1% in Q3 2015). This is in part due to the overall trends facing the Restaurant industry and in part due to their own success. It is...


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