Should You Consider Sonic Over McDonald's and Burger King?

Should You Consider Sonic Over McDonald's and Burger King?

Sonic is the largest drive-in restaurant chain in the United States. That might impress some investors, but how many drive-in restaurant chains do you know of? That said, many consumers speak highly of Sonic, its food offerings, and unique experience. We'll take a look at one of Sonic's most recent moves, how it compares to recent moves made by Burger King and McDonald's , Sonic's comps performance and expectations, and whether or not Sonic looks to be a quality investment.

Several improvements
In fiscal year 2013, Sonic's overall comps increased 2.3% year over year, with company-owned drive-in comps improving 2.5% and franchise drive-in comps growing 2.3%. Sonic attributes its comps growth to product quality improvements, more personalized service, and a tiered pricing strategy.

Sonic expects its fourth-quarter comps to grow at a 5.9% clip, with company-owned drive-in comps and franchise drive-ins increasing at 6% and 5.2%, respectively.

In FY 2014, Sonic has stated that it expects positive comps as well as full-year EPS growth of 14%-15%. This is in addition to the repurchase of $40 million of its own stock. With only $15 million-$25 million expected to be generated in free cash flow, the remaining capital used for the repurchase will be taken from the company's cash position. However, with a cash position of $77.90 million versus long-term debt of $474.16 million, this should give investors at least a little pause.

Sonic currently sports a debt-to-equity ratio of 6.12. This works in the current economic environment. However, interest rates will eventually increase which will impede the company's growth potential and may lead to Sonic offering lower capital returns to its shareholders. Once again, this isn't a concern at the moment but it's something to keep an eye on. For now, let's keep an eye on Natural-Cut Fries.

Keeping up with competitors
Sonic is a much smaller company than McDonald's and Burger King. Therefore, it must keep itself unique in order to drive demand. After Burger King launched its Satisfries, Sonic had to make a move.

Sonic's Natural-Cut Fries are made from whole russet potatoes, which gives the new fries their crispy crunch. Sonic didn't jump into this new innovative product blindly. It first conducted several consumer tests, and the results were that the Natural-Cut Fries scored higher in quality, crispiness, texture, and for overall experience than Sonic's previous fries. That being the case, Sonic's Natural-Cut Fries have the potential to aid the top line. Even if Sonic can't attract many new customers, loyal customers are likely to be somewhat interested in testing out the new fries, which adds an item to some orders.

However, Sonic's Natural-Cut Fries aren't likely to attract as much attention as Burger King's Satisfries, which offer 40% less fat and 30% fewer calories than Burger King's former fries. Not only is the name Satisfries catchier than Natural-Cut Fries (this does matter), but Burger King has more marketing power. Burger King didn't slow down after introducing Satisfries. It also recently launched the Big King sandwich, which includes:

  • Two 100% Pure Beef Fire-Grilled Patties

  • Lettuce

  • Onions

  • King Sauce

  • Three-Layer Toasted Sesame Seed Bun

Burger King is making strategic moves in order to drive demand, but it still doesn't have as much marketing power as McDonald's. While the recent news for McDonald's French fries hasn't been all positive (many consumers aren't happy with the 17 ingredients found in the fries), McDonald's doesn't need to alter its fries much since they have been known as the best in the fast food market for decades.

McDonald's has also launched many innovative menu items, including Mighty Wings, Pumpkin-Spice Latte, and the Premium Southwest McWrap. All of these are limited-time offers. That said, if one of them performs exceptionally well, it has potential to be added to the permanent menu.

McDonald's must be doing something right, because its October comps just increased 0.5%. That's not a great number, but it's still a positive in a difficult environment. APMEA (Asia-Pacific, the Middle East, and Africa) dragged down this number with a 2.8% comps decline. In the United States, comps improved 0.2%, and in Europe, comps grew 0.8%. McDonald's will continue to focus on menu quality and choice, improved customer service, and affordability for growth.

In addition to broad geographic diversification and marketing power, McDonald's yields 3.30%, versus a 1.40% yield for Burger King and no yield for Sonic.

The bottom line
Sonic seems optimistic about its future, which is always a big positive. However, its Natural-Cut Fries aren't likely to steal consumers away from Burger King and McDonald's. Additionally, Sonic is highly leveraged which is likely to negatively impact growth potential at some point down the road. The irony here is that in the current low interest rate environment, it doesn't matter. Sonic might continue to grow and reward shareholders without a problem. This would lead to stock appreciation.

However, if you're looking to invest for the long haul then it might be wise to consider best of breed, which is McDonald's thanks to its broad geographic diversification, constant innovation, marketing power, resiliency, debt-to-equity ratio of 0.89, and 2.20% yield. You might not see as much stock appreciation as Sonic could provide over the near to medium-term, but McDonald's is highly likely to outperform Sonic over the long haul. Those generous dividend payments don't hurt, either.

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Dan Moskowitz 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.

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