Sonic Has Some Catching Up to Do

 | Jun 22, 2012 | 4:30 PM EDT
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Despite the market's sour mood on Thursday, there were some positive developments for a few names that I own or follow. Yes, there actually was some green on my screen yesterday, amid the sea of red.

Fast-food name Sonic (SONC) reported a better-than-expected quarter after the close on Wednesday, beating the earnings consensus of $0.22 a share by $0.02. Shares were up 3% on Thursday. Revenue fell for the quarter, but that was because the company refranchised 35 stores.

That's good news, and we'll be seeing more of this, I believe, from chains that have company-owned stores and franchises. The franchise model makes more sense for some names, it can be more profitable, and it shifts more of the risk to the franchisee.

Denny's (DENN) has been refranchising the past couple of years, and this move has helped in the company's turnaround, which is not yet complete. Sonic's performance has not been good in the past few years, and the stock has been one of the worst-performing restaurant names at a time when the sector as a whole has been delivering nice returns to shareholders.

Sonic, although it is challenged, has never imploded like Denny's did in the late 1990s. Still, Sonic has a lot of work ahead. The company's balance sheet is nothing to write home about, with more than $500 million in debt, which equated to $32 million in interest expense last year, and less than $49 million in equity.

There are, however levers that Sonic can pull. At year-end, the company owned more than 400 locations, and this should help it reduce its debt. Denny's has been fairly successful in this area, selling properties and reducing debt from more than $550 million in 2005 to $210 million at the end of last quarter. Sonic needs to follow that lead. The company has been buying back shares, completing a $30 million repurchase program earlier this month, but I believe it needs to better address the debt issue.

Sonic is not small chain -- it has 3,550 locations. And it has differentiated itself somewhat from other fast-food chains, but this space remains highly competitive. Same-store sales were up 2.8% for the quarter, which is decent. But I need to see further progress on the balance sheet before I deploy any capital.

I'm already restaurant-heavy as it is, with a few challenged names such as Cosi (COSI), Ruby Tuesday (RT) and Wendy's (WEN). My Biglari Holdings (BH) position adds more exposure, given the company's ownership of Steak n Shake, and I hold a large position in Cracker Barrel (CBRL).



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