SONC – Management Not Conservative Enough

Just three and a half weeks ago, SONC issued its FY09 EPS expectations of up 12%-14%. Even in that short time period, management stated today on its earnings call that the landscape has changed rather dramatically. Although SONC did not change its guidance today, management said that current credit conditions could impact its franchise development target of 155-165 new openings, on which the 12%-14% EPS growth relies. SONC then went on to say that a lot of its franchisees are well capitalized. When asked specifically why they are not lowering their EPS guidance to a more cautious range based on the risk to the company’s development schedule, management said, “If we thought we should pull back, we would” so there appeared to be a lot of hedging on the part of management as it relates to current visibility.
  • Prior to today’s call, I thought SONC’s FY09 EPS expectations were aggressive, and although they still seem to be, I did not realize before today that half of this growth is expected to come from refranchising gains. So really only 6%-7% of SONC’s EPS growth relies on operations and those targeted 155-165 franchise drive-in openings. Instead, SONC’s ability to achieve 12%-14% EPS growth focuses largely on the timing of partner drive-in sales to franchisees. Despite management’s assurances that so far no transaction has been impacted by the current credit markets, this remains a real risk for the company.
  • I am also less than confident in SONC’s ability to return to flat partner drive-in same-store sales growth for FY09 following the 3.9% and 6.3% declines in 3Q08 and 4Q08, respectively. Although the company will be lapping easier comparisons in the back half of the year, if current trends continue into 1Q09 and 2Q09, SONC would need to generate 5%-plus numbers in 2H09, which would be a significant improvement from current trends. SONC’s partner drive-in’s average check has been hurt by the introduction of its Happy Hour promotion, which drives increased traffic at the expense of average check and margins. The company will be lapping this introduction in November so that should benefit numbers on a year-over-year basis.
  • SONC’s 1Q09 results should continue to be hurt by lagging sales results because although the company is seeing improved customer service scores, I don’t think SONC will see a quick turnaround in trends in this environment. Additionally, SONC expects its commodity cost to be up high single digits in the first quarter as it is currently experiencing beef prices (12% of SONC’s costs) up in the 30%-35% range.

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