Drive-in fast-food restaurant Sonic (NASDAQ:SONC) happens to be one of the earliest companies I covered for InvestorPlace. Sonic stock was also one of my more questionable and frustrating calls.
Three years ago, I felt that volatility in Sonic stock was overdone, that management would turn the company around.
However, shares never engendered much confidence.
Issues with Sonic Stock
The issue with Sonic was that I was both right and wrong on multiple occasions. In June 2015, I acknowledge the company’s woes and management’s miscues.
At the time, Sonic was busy engaging its expansion plans. It opened several stores, including those in weather-challenged states like North Dakota.
Any red-blooded American understands the appeal of Sonic’s drive-in burger chain, which hearkens back to a bygone era. The summer season is the perfect time to cruise out in a covertible, and enjoy the frivolities of capitalism.
But the winter season takes a huge toll on the restaurant’s business. Installing weather-specific renovations, including indoor seating areas, failed to resonate with customers.
That said, Sonic was also aggressively expanding into California, which makes sense. Markets like Los Angeles and San Diego essentially have variations of summer all year long.
Plus, California has a love affair with the automobile that few other states can rival.
Unfortunately from my perspective, Sonic stock proceeded to resemble a seismograph. In some months, I was up, but mostly, my call fell short.
Fundamentally, revenue growth turned from flat to sharply negative as Sonic routinely failed to attract customers. The only way to sustain positive earnings was to trim its footprint, which they did.
But based on the recent burst in Sonic stock, am I ready to re-embrace the drive-in restaurant? Not quite.
Rising for the Wrong Reasons
On a year-to-date basis, Sonic stock is up over 31%. Ordinarily, such a move calls for a celebration. But prior to the run-up, the markets weren’t feeling the burger chain one bit. At the end of May, Sonic was actually down double digits.
So what happened? On June 7 management announced that it would buyback its shares. Specifically, Sonic instituted a new share-repurchase program of $500 million, replacing the prior $160 million program.
After the announcement, basic supply-and-demand economics took over. With fewer shares diluting the markets, each available one became more valuable.
The issue that I’m sure several analysts have is that management is making a cynical move. They realize that their prior expansion plan hasn’t worked out that well.
Rather than tie-up their balance sheet with equity capital in a low-growth environment, Sonic decided to call it in.
Granted, this isn’t a bad decision, and perhaps it’s the only one. Several fast-food companies, including McDonald’s Corporation (NYSE:MCD), Jack in the Box Inc. (NASDAQ:JACK), and Yum! Brands, Inc. (NYSE:YUM), are seeing red in the markets.
At this juncture, it’s not productive to share ownership.
But you as an investor shouldn’t fall for this “ruse.” Yes, reducing outstanding shares drives up the earnings per share metric.
However, as The Motley Fool’s Jeremy Bowman points out, prospective buyers should wait for “more fundamental improvements in the business.”
We’re just not seeing that. In its latest fiscal third quarter earnings report, Sonic stock exceeded consensus EPS targets.
But on the total revenue and same-store sales front, it was the same, old story: Sonic fell short of expectations. The burger chain also guided down Q4 EPS estimates to between 46 and 50 cents, well below the 53-cent consensus.
In other words, buying this rally is incredibly risky.
Treat Sonic Stock Like the Insiders Do
If you happened to have bought SONC stock around the time I wrote my piece three years ago, and if you’ve held it thus far, I think it’s a great time to unload.
The drive-in restaurant business model resonates due largely to nostalgia. But from a revenue perspective, it simply doesn’t generate traction.
One bright spot is Sonic’s New York City region. There, the company has experimented with new menu items offered through food trucks. It also created an ordering app so that customers can skip long lines.
The revamped business sounds promising, except for one catch: apparently, for Sonic to regain its past glory, management must overhaul the drive-in model entirely. But if they do that, they’ll lose their signature hallmark, relegating them to any number of nameless, faceless fast-food joints.
Perhaps they can make it work. But everything I’ve learned over the last three years about Sonic is that it’s a hot mess. Regrettably, I don’t think anything has changed.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.