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Sonic reported earnings after the close yesterday and beat expectations for both revenues and earnings.  The focus of the call was on sales trends that slowed in May and June.  Is the slowdown temporary or will hot dogs save the day?


Management went through a very detailed explanation as to why sales trends slowed in May and June but stopped short of saying what the magnitude was.  All they said was that the slowdown was limited to guests coming in after 8pm.  In May and June 2011 the company is lapping a buy-one-get-one-free shake promotion, which generated significant traffic; expectations are for low single same-store sales for 4Q11. 


For the balance of the quarter the “hope and expectation” is that the BAJA hotdog (along with a new line of shakes) at $1.99 will bring back some incremental traffic.  The irony in all this is that despite the SONC customer having been so responsive to the company’s value initiatives, management apparently feel comfortable raising menu prices.  


Sonic reported EPS of $0.21 excluding extraordinary items on the back of strong same-store sales growth and improved margin that management attributed to labor efficiencies that were offset by increased commodity costs and investment in product quality.


Company-operated same-store sales came in at +6.5%, beating expectations of +6.1%, which implied a two year average trend of +0.1% or 650 basis points higher than the two-year average trend in 2QFY11.  Management stated that the premium six-inch hot dog promotion which is driving traffic across all day parts.  The company had an effective year-over-year price increase of +1.5% on the menu in April and May which was then increased at the beginning of this month as an additional 0.5% price increase was implemented with the new menu.  The 2% price currently on the menu is not expected to begin rolling off until April of next year.


SONC: SOLID BEAT, BUT... - sonc pod1


The improvement in the company’s performance is reflected by the marked improvement in customer satisfaction scores at company and franchise stores versus the satisfaction scores that the company was reporting in fall 2008.  Over that period, company and franchise customer satisfaction scores have improved from 59% to 78% and 69% to 77%, respectively. 


Restaurant level operating margins expanded for the first time since 2009.  The improved top-line performance helped margins as food and packaging costs were better than expected due to less discounting and more aggressive price increases than originally planned.  Other operating expenses were favorable reflecting leverage from the company-owned same-store sales trends.


SONC: SOLID BEAT, BUT... - sonc pod2



Sonic is launching a new Baja hotdog in July that it hopes will, in combination with the loaded burger promotion, drive traffic and check.  In addition a new line of Real Ice Cream Shakes will be released which, in conjunction with the other products and promotions on offer, management is expecting to drive positive sales in the fourth quarter. 


One area management is focusing on going forward is the after 8pm day part which was slower in the third quarter than one year prior and has been a primary contributor to the slowing of SONC’s business over the last few weeks.  With respect to margins, labor costs are expected to be favorable in the fourth quarter and the other operating expense line is expected to improve again.


Food cost inflation in the third quarter came in lower than expected, between 5 and 6%, and management expects fourth quarter food inflation to come in below that range.



Howard Penney

Managing Director

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Right Said Fed

“I’m a model. You know what I mean. I do my little turn on the catwalk.”

                -Right Said Fred, “I’m Too Sexy”


Conclusion: The Fed today provided further support to our Indefinitely Dovish thesis, which postulates that interest rate policy will stay at, or below, current levels well into 2012.  In addition, the door for QE3 was opened ever so slightly based on our read.


The FOMC statement today continued to verify our thesis of Indefinitely Dovish.   The interesting change in this statement versus the last statement is an acknowledgement of slower than expected economic growth and a jobs recovery that is more muted than versus the last FOMC statement in late April.  The outcome of these two changes is that the Fed has, tacitly, taken down its expectations for inflation based on this statement in the release today:


“Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy other commodity price increases dissipate.”


He reiterated this in his press conference in which he said, “inflation remains well anchored.”


Our read through on this is that these statements are a shift and in contrast to Chairman Bernanke’s statement at the International Monetary Conference in early June when he said:


“That said, the stability of inflation expectations is ensured only as long as the commitment of the central bank to low and stable inflation remains credible. Thus, the Federal Reserve will continue to closely monitor the evolution of inflation and inflation expectations and will take whatever actions are necessary to keep inflation well controlled.”


Reading too much into snippets of Fed Speak is dangerous at best, but it does provide some insight into what could happen next.  The Bernank is now admitting both that the economy is getting worse and that he believes that the outlook for inflation is now likely to be at lower than normal levels going forward.  So, the door has now been cracked open for Quantitative Easing 3.


We continue to believe to actually implement QE3, the Fed will need sustained negative monthly payrolls.  Prior to QE1, this was 9 negative months, while prior to QE2 this was 3 negative months.  In May, non-farm payrolls came in at +54K, which was an eight month low.  The June nonfarm payrolls will be released on July 8th and will be the key measure as to the direction of monetary easing from here.  If we get a negative print, QE3 will be solidly on the table.


That said, the Fed will likely not implement additional easing while inflation, as measured by CPI is accelerating. While we have been of the view that reported inflation will continue to accelerate or be heightened during the summer and into the early fall, by early Q1 2012 this should reverse. Thus, heading into 2012 tougher comps on commodity inflation will potentially lead to deflationary type concerns, or at least give the Fed complete cover for incremental easing, especially as the labor market is likely to remain challenged.


As part of today’s Federal Reserve events, the Fed released their update economic projections based on the “models” of the Board Members.  For 2012, they are taking down growth expectations, taking up unemployment expectations, and increasing inflation expectations.  At Hedgeye, we actually call slowing growth, increasing unemployment, and increases inflation, Jobless Stagflation.


In the press conference, Chairman Bernanke also indicated that keeping the federal funds rate at 0 to 0.25% for an extended period means for at least 2 – 3 FOMC meetings.  This of course continues to extend Bernanke’s tenure as the most accommodative Chairman in, well, the history of the Federal Reserve.  This is outlined in the table below.


Right Said Fed - DJ


If there is anything we can take away from the Fed’s projections, it is that they are based on lagging indicators and are seemingly inaccurate as it relates to actual economic outcomes.  Collectively, this is a little disconcerting since monetary policy is set and based on these “projections”.


You know what I mean?


Daryl G. Jones

Director of Research


Given the 5% increase in May passenger volume, total Strip gaming revenue growth could have reached double digits.



Following a disappointing April, May appears to have been a much better month on the Las Vegas Strip.  McCarran Airport just released May data that showed the number of enplaned/deplaned passengers grew 5.1% YoY, against a -1.6% comp.  In April, passenger volume increased 2.3% (-5.0% comp).  Despite the positive growth, April gaming revenues actually decreased 2.3% on the Strip despite a modest comp of down 0.9% in April of 2010.


Using our predictive model, we estimate that May Strip gaming revenues will increase 8-12% assuming positive auto traffic, normal hold percentages, negative slot handle per visitor, and positive table drop per visitor.  Last year, May gaming revenue fell 6.4% so the comp is easy, due in part to below normal table hold percentage.  Here are our estimates for May: