Tickers in this Article: SONC, PNRA, CMG, MCD, DNKN, WEN
Americans love to eat out and they seem to love store concepts that offer a break from burger-world - witness the growth at concepts like Panera (Nasdaq:PNRA), Chipotle (NYSE:CMG) and Dunkin' Brands (Nasdaq:DNKN). Of course, that's not to say that burger-world is exactly suffering either; McDonald's (NYSE:MCD) has been remarkably and consistently strong and newer concepts like Five Guys are also doing well.

Sonic (Nasdaq:SONC) definitely offers a different concept with its drive-in store format and a menu that offers many foods and drinks that cannot be found at other national or regional QSR chains. So far, though, "different" hasn't really meant better, as Sonic has struggled to deliver really exciting growth over the years.

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Good Results in Q3 ... or Were They?
Sell-side analysts seem to be pretty pleased with the earnings that Sonic reported this quarter, but I'm not completely sold that the results were really that great.

Yes, comps were up 2.8% on a company-wide basis and, though those were announced earlier (before earnings), they were a fair bit better than prior expectations. Still, these results aren't that exceptional. Company-owned comps were up 3.7% (and franchisees saw 2.7% comp growth), but established giant McDonald's had a 4.4% U.S. comp in May and Chipotle's comps are running in the double-digits.

Overall revenue fell about 2%, though, as positive comps were offset by some store closings. Restaurant-level profits were up 5%, though, and the company saw restaurant margins rise more than a point. Likewise, company operating income rose 7% and the company is doing a good job controlling its food, labor and advertising costs.

Can Sonic Win with Value?
McDonald's has been remarkably successful with its value menu, so much so that other companies like Burger King and Wendy's (Nasdaq:WEN) have little choice but to join in. Sonic, too, seems to be trying to create a more value-oriented menu, but this may not really work to the company's advantage. I question whether Sonic really has the scale to compete effectively in the value segment and this could be hard on margins.

Will Sonic Turn Different into Better?
While I clearly have some issues with Sonic, I do think there's still a potentially interesting restaurant growth story here. Unlike many QSRs, Sonic already does well during breakfast, and the company has an attractive niche with specialty drinks. At the same time, the company has been pretty aggressive in dropping unsuccessful menu items and refreshing its offerings with new (and unique within QSR) products, like sweet potato tots.

It's also worth asking if some of Sonic's relatively depressed growth is a byproduct of where the company has most of its franchises. Sonic has a lot of its store base in the South/Southeast and that region has some of the worst unemployment rates in the country right now. So if Sonic can just get through this tough economic patch, perhaps it can make more ground with its distinctive menu. That said, the company has a lot of debt and this may be a barrier to a more aggressive store expansion plan; at a minimum, it makes it more likely that growth will have to be led by franchisees who can bring capital with them.

SEE: Is Buying A Franchise Wise?

The Bottom Line
Just how cheap is Sonic? On a trailing EV/EBTIDA basis, Sonic definitely seems undervalued, relative to faster-growing peers like Chipotle, Panera and Dunkin. It's also cheaper than McDonald's; but with significantly lower operating margins (and a stretched balance sheet), doesn't it seem that Sonic should carry a lower multiple?

Turning to cash flow, Sonic may be undervalued but there's definitely some risk in the picture. If Sonic cannot improve its free cash flow growth trajectory over the levels of recent years, the stock is not really cheap at all, when factoring in the debt. But if Sonic can reignite growth and deliver high single-digit growth over the next ten years, maybe these shares can offer some unappreciated potential to patient investors.

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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