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Conclusion: SONC is not yet out of the woods from a top-line perspective, but margins are stabilizing and the company could emerge from the “deep hole” as early as 2QFY11

SONC posted a sequential improvement in comparable restaurant sales yesterday.  System-wide same-store sales declined 2.4% during the first quarter versus a 6.5% decline in the same quarter a year prior.  StreetAccount consensus was calling for a comparable restaurant sales number of -3.2%. 

Turning to our quadrant chart, it is clear to see how poorly SONC has been performing over the past 5 quarters.  From a sales perspective, partner-drive in comparable restaurant sales have declined for 11 consecutive quarters.  We anticipate the company moving out of the “Deep Hole” quadrant by next quarter and remaining safely out in 3QFY11.  The company is seeing stabilization in margins and faces easier comparisons in 2QFY11 than last quarter.  From my model, I see restaurant level margins being approximately flat to up slightly next quarter and positive in 3Q.  While this is largely due to exceedingly sharp restaurant level margin declines in the year prior, results in this range would be a significant improvement from the last 5 quarters of significant margin erosion.

From a sales perspective, things continue to trend in a positive direction.  While the company’s guidance for sequentially improving same-store sales throughout the year seems like a stretch on a one-year basis after fiscal 2QFY11 (partner drive-ins are lapping an easy -14.9% comp during 2QFY11 and a -13.2% comp on a system basis) , two-year trends should continue to improve.  Given my view that MCD’s comps will slow as the company’s beverage business will fail to maintain the same level of trial, Sonic should have less of a headwind to face in the back half of the year from a market share perspective. 

SONC: LESS BAD IS GOOD - sonc quadrant

From a sentiment perspective, Sonic is not particularly well-liked by the buy-side or sell-side.  The average short interest in the QSR space, excluding the outliers GMCR and PEET, is 4%.  Sonic’s short interest is currently at 6% which is one of the highest in the space.  While that hardly makes it the runt of the consumer discretionary litter, it is noteworthy that Sonic is one of the few stocks that have seen an uptick in short interest over the past couple of months.  

SONC: LESS BAD IS GOOD - qsr short interest

The sell-side also has a negative view of SONC.  Given an improving top line and margin trends that should improve significantly this fiscal year, I think there is a strong possibility that this chart will change markedly over the course of the next 6-9 months (especially if my view on MCD is correct).   We are nearing a turn in sell-side love, or at the very least, a decline in sell-side bearishness.

SONC: LESS BAD IS GOOD - sonic sell side ratings

Howard Penney

Managing Director