In our power rankings of stocks in the QSR restaurant universe, SONC is the most under loved name next to SNS, a name which hardly anybody cares about.  


SONC, MCD, JACK and BKC are the only QSR names that are down on a year-to-date basis.  The rest of the group is up over 50%.  Of these four names, I’m more favorably disposed to JACK and now warming up to SONC.  




SONC reported fiscal 4Q09 system same-store sales growth of -4.5% with partner drive-ins down 5.4%.  Sales trends at the partner drive-ins have been significantly underperforming the franchise drive-ins for the last 5 quarters and although partner drive-ins improved 230 bps sequentially from 3Q09 on a 1-year basis, the 2-year average trends continued to decline slightly (though they appear to be stabilizing).  The reported flat traffic result is somewhat impressive relative to the current environment, but average check declined 4.5% YOY, similar to the 4.9% decline in 3Q09. 






SONC attributed its flat traffic number to the success of the company’s Everyday Value Menu, which was implemented in 2Q09.  The Everyday Value Menu is also accountable for the decline in average check.  Restaurant level margins started to decline prior to the introduction of this value menu to the tune of about 400 bps in both 4Q08 and 1Q09.  The value menu already accounts for 10% of sales but its negative impact on margins was somewhat offset in 3Q09 as a result of the company’s refranchising efforts.  Restaurant level margins most likely declined again in 4Q09, though to a much lesser degree than the 200 bp decline in 3Q09, as a result of the July minimum wage increase and the expected increase in food costs as a percent of sales.  This increase in food costs as a percent of sales is being driven by the lower margin Everyday Value Menu because commodity costs were expected to be down YOY in the fourth quarter (lapping the 4Q08 180 bp increase in food costs as a percent of sales).




SONC guided to improved restaurant level margins in fiscal 2010, which would be encouraging after five reported quarters of rather significant declines.   This guidance also assumes flat partner drive-in same-store sales, which implies an acceleration in sales trends on a 2-year average basis.  Although the company is relying on the full-year benefit of it 2009 refranchising activity and lower commodity costs to drive restaurant level margins higher, we have yet to see any recovery in SONC’s 2-year average partner drive-in comparable sales trends (though they are not getting worse).  And, if the value menu continues to grow as a percent of sales, it will continue to put pressure on average check and food costs as a percent of sales, offsetting some of the YOY commodity cost favorability. 


From an operating margin perspective, the company’s expectations for significantly lower YOY SG&A and D&A expense as a result of refranchising efforts should lead to better operating margins in fiscal 2010 even if restaurant margins don’t prove as favorable as expected.


On a separate topic, SONC also announced that it has implemented a program intended to encourage franchise openings in fiscal 2010.  Part of this program is likely to include lower required average franchise fees per new franchise opening.  The company is still guiding to 100-110 franchise openings in 2010, but this type of change signals a decrease in franchise interest.

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