Sonic Corp. Lowering Second-Quarter Estimate on Likely Weather Impact

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Analysts are lowering the fiscal second-quarter EPS estimate for Sonic by $0.02, to $0.03, below the consensus of $0.06 and versus $0.05 in the year-ago period, to reflect the likely impact of harsh winter weather throughout the February quarter.

We are lowering our system-wide same-store sales estimate to about -1%, down from our prior estimate of 1% to 2% (which was in line with the consensus). We anticipate a company-owned comp decline of roughly 2% in the quarter against a 1.9% comparison, inclusive of an approximate 3% to 4% decline in traffic partly offset by an estimated 2% increase in average ticket, along with franchise comps in the flat to -1% range against a -0.3% comparison.

We expect restaurant contribution margin to be roughly flat at 11.8%, as favorable food costs are offset by deleveraging on negative comps. Specifically, we project a 30- basis-point decrease in cost of sales, to 27.8%, as a price benefit more than offsets food inflation (in line with guidance for favorable second-quarter food costs); a 30- basis-point increase in labor, to 37.9%; and flattish other operating expenses at 22.5%. Combined with a 130-basis-point increase in SG&A expense, to 15.2%, and an 80-basis-point increase in D&A, to 9.9%, on soft sales, we expect overall operating margin contraction of 230 basis points, to 8.5%.

We believe that Sonic remains on track to have the company’s new POS system in place at all company-owned locations this summer (versus just over 70 as of early January), followed by a broader rollout to franchised locations through fiscal 2016. Sonic’s new POS system and supply chain management system are expected to play a significant role in returning restaurant-level margins to the 16% to 17% level in the next two years (from 14.7% in fiscal 2013), with better order accuracy and speed and integrated back-office tools designed to detect employee theft, improve labor scheduling, and optimize inventory control and minimize waste (projects sales forecast based on history and suggests inventory orders). The new POS system serves as a critical enabler for POPS, which is currently in a handful of markets (fewer than 100 drive-ins). POPS features digital menu boards that have been shown to increase traffic, average check, and profitability.

Given the likely impact of weather in the second quarter, we suspect that management will lower fiscal 2014 guidance, which was previously for EPS growth of 14% to 15%. However, since the second quarter is the lowest profitability quarter of the year, we expect the guidance reset to be relatively modest, likely calling for EPS growth in the 12% to 13% range. Our new fiscal 2014 estimate is now $0.80 (up 12%), versus the consensus of $0.82 (up 14%).

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