America's Drive-In Is the Place to Be

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Sonic (NASDAQ: SONC) is known as America's drive-in. The company operates over 3,500 restaurants in 43 states. The restaurant is known for its hamburgers, hot dogs, french fries, milkshakes and other Americana fare. It is best known for its food being delivered by carhops, whereby a waiter or waitress brings the food to the car, sometimes on roller skates.

Latest quarterly results

For the latest quarter, earnings per share doubled from last year's level. Earnings per share came in at $0.06 compared to $0.03 last year. Margins were better across the board as the gross margin was 50.5%, operating margin was 10.8%, and net margin was 3.2%. The company repurchased $6 million of its common stock and paid down $23.7 million in debt.

Outlook going forward

Where Sonic's management is particularly focused is on cutting costs. The company is implementing a new point-of-sale and supply chain management system. These will work to improve profitability and margins across the board.

In 2015, Sonic will benefit as approximately 850 licensees will go to a higher royalty rate. This will be a significant contribution to earnings as the company doesn't have to do anything to get this extra money. It will flow directly to the bottom line.

The company is also doing more to increase its brand awareness. Sonic is still not in every market and has significant room to grow. Consider that there are currently only five Sonic restaurants in New York, and that many people have never even heard of Sonic before. The company is looking to change that with its increased media buying. Now 70% of all ad-buys are on national cable. Before it was a 50-50 split with local television and radio.

To appeal to more potential franchisees, Sonic now offers a smaller building prototype that requires less of an investment. The new building design reduces non-land costs by 15% to 20%. Sonic also offers new franchisees an ascending royalty rate. The goal is to open more restaurants and get the Sonic concept into more markets. There are still seven states that don't have a Sonic and the company wants to target potential franchisees in new markets.

To get the word out about becoming a franchisee with Sonic, the company will be at the International Franchise Expo at the Javits Center in New York. Many franchise opportunities are still available and the company is hoping to partner with franchisees that can bring Sonic to new markets.

To help boost sales in the afternoon, Sonic launched a “Happy Hour” between lunch and dinner. Sales are usually slow during this period and the company discovered that afternoon snacking is growing. The afternoon segment now accounts for 23% of Sonic's revenue. Sonic advertises 1 million beverage permutations are available at its restaurants. These drinks are half-off during “Happy Hour.”

The competition

There is no shortage of competition for Sonic in the fast-casual restaurant space. Of course the biggest competitor for Sonic is America's original drive-in chain McDonald's (NYSE: MCD). McDonald's is the world's largest chain of hamburger fast-food restaurants and is on practically every corner in America.

Even though it doesn't have room for expansion in the U.S. like Sonic, McDonald's is a tough competitor in innovation. The company is continuing to improve its menu items and is rolling out its McCafe's to capture the drink business. McDonald's has also done a great job of luring the value-conscious customer into its restaurants with its “Dollar Menu.”

McDonald's has been in a sales slump for most of this year. Things are starting to turn around, though, with same-store sales increasing 2.6% in May. This trend looks set to continue into the summer months as McDonald's continues to respond to its customers by adjusting its menu items. The company currently has 140 items on its menu and has 160 new items in the pipeline. McDonald's is offering more nutritious items and is looking to expand the time it serves breakfast items, which have higher margins than lunch or dinner items.

McDonald's has the best management in the business and it is quick to address any slowdown in sales. Shareholders are also comforted by the 3.1% dividend yield.

Another major competitor for both companies is Burger King Worldwide (NYSE: BKW). Burger King is not on every corner like McDonald's, but the company does have a much bigger footprint than Sonic. Burger King has been dealing with a weak start to the year as well with comparable-store sales down 1.4%. Profits have still been going strong though as the company has been aggressive in cutting costs and expenses.

Burger King has been adjusting its menu to keep up with the competition. This summer the company will launch the “BK Rib Sandwich” to go up against McDonald's popular “McRib.” Burger King is also launching a delivery service for its menu items. The program is already performing well in New York, Miami, Houston, Los Angeles, Chicago, San Francisco, and Washington, D.C. Phoenix, Denver, Las Vegas and Sacramento, Calif. are due to get the service next. Orders can be made online or via the telephone and the food is delivered as promised thanks to proprietary thermal-packaging technology.

Burger King is looking to be active in returning cash to shareholders. The company just raised the dividend by 20% and initiated a $200 million share buyback.

Foolish assessment

The fast-casual restaurant business is a great business to be in. All three companies are solid players, but I see Sonic as having the most room for growth. There are plenty of opportunities to increase the company's presence in the U.S. and I see that benefiting shareholders as revenue and profits increase.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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