Sonic (NASDAQ: SONC) is the nation's largest chain of drive-in hamburger restaurants. Sonic's drive-ins recreate the diner feel of the 1950s featuring American classics and rollerskating carhops. The company operates more than 3,544 drive-ins coast to coast, of which approximately 86.6% are franchised. Sonic is primarily concentrated in the Deep South with its top 5 markets (including Texas, Oklahoma, Tennessee, Arkansas and Missouri) representing over half of its store locations. In addition to its sizable presence in the South, Sonic operates in 35 states across the continental United States.
Sonic's drive-in concept, carhop delivery service and signature menu are hallmarks of a classic American diner experience that differentiates the company from its competitors. Despite this important advantage, Sonic faces a few key challenges moving forward. First, the company has negligible international exposure making it wholly dependent on the U.S. where soaring food and energy prices, the housing slump and a weakening job market are taking a toll on restaurant spending. Sonic's concentration in the South has so far shielded it from the the worst of the U.S. slowdown. Economic activity in regions dominated by the energy industry has remained robust with relatively tight labor markets in states like Texas, Oklahoma and Mississippi. Still, the company's exclusive reliance on the U.S. make it susceptible to a general pullback on the part of U.S. consumer. Furthermore, rising costs for food inputs like wheat, dairy and beef are taking a bite out of gross margins.
In 1953, Troy Smith, opened Sonic's first predecessor, Top-Hat, in Shawnee, Oklahoma. Since its founding the company has seen significant growth and expansion across the U.S; as of August 31, 2009, the Company had 3,544 Sonic Drive-Ins in operation from coast to coast, consisting of 475 Partner Drive-Ins and 3,069 Franchise Drive-Ins. The company operates primarily in the Deep South with Texas alone accounting for 950 of it's drive in locations.
Sonic is built upon a strong owner/operator philosophy, in which managers have an equity interest in their restaurants, providing an incentive for managers to operate restaurants profitably and efficiently. The company exercises this philosophy through both its Partner and Franchise Drive-ins. In its Partner Drive-ins, Sonic typically owns a majority interest (at least 60%) and the supervisor and manager of the drive-in own a minority interest. Sonic franchises the majority of their restaurants. Through its franchise system, a franchisee, usually a local entrepreneur, requests permission from the company in order to open a Sonic Drive-in restaurant. The company's franchising agreement requires the franchisee to provide the initial capital for equipment, signs, seating and decorations. Meanwhile, the company owns or obtains long-term leases for the building of the restaurant and the land. These franchises generate revenue for the company through payment of rent, royalties based on sales, and initial fees. The company then avoids having to invest a significant amount of capital in its restaurants.
During 2009, Sonic opened 141 new stores. 11 of these were partner stores, while the remaining 130 were franchises. Sonic states that it plans to expand more in 2010, but has not set a target goal on the number of stores it wishes to open.
In 2009, Sonic earned a total of $719 million in total revenues, a decline from its 2008 total revenues of $804.7 million. This in turn had a negative impact on its net income. Between 2008 and 2009, Sonic's net income declined from $60 million in 2008 to $49 million in 2009.
Sonic's margins are dependent on food prices. In particular, the company is dependent on the price of corn, beef and also oil. The prices of many key inputs have risen and could affect the profitability of the firm in years to come. The price of corn, which is fed to livestock and is also a key input in many processed foods, has doubled in the last two years, due in part to the ethanol boom. Because it now costs more to feed the cattle, the price of beef and chicken, two extremely important inputs for a fast food restaurant, has also risen. In addition, oil prices have risen four-fold since 2001 and the price of gas is also up 67% in the last year alone. Oil is used to produce food, as well as to transport it all over the world. Finally, the price of food has risen due to higher demand in developing countries like China and India. Intense competition if the QSR industry encourages Sonic to absorb these costs rather than passing them onto customers and losing market share.
Soaring food and energy prices, the housing slump and a weakening job market have a negative impact on restaurant spending in Sonic's core North American market. Unlike competitors such as McDonald's, Yum! Brands (YUM) which have sizable international presences, Sonic operates almost exclusively in the United States. However, it is precisely because of this concentration in the South that may allow Sonic to escape the worst of a U.S. slowdown. States like Texas, Oklahoma and Mississippi have seen growth due to their large energy industries. Still, the company's exclusive reliance on the U.S. make it susceptible to a general slowdown in U.S. consumer spending.
Sonic has launched a "Happy Hour" initiative. During "Happy Hour" Sonic's drinks are offered at half price between 2-4pm everyday- no alcohol of course, just soft drinks and slushies. Sonic is also rolling out a new line of premium coffees, consisting mostly of espressos and lattes. Because most successful fast food chains draw foot traffic through new menu introductions, these two initiatives can be see driving future traffic into Sonic stores. These new initiatives draw new customers, offsetting the effects of a spending slowdown.
The Quick Service Industry (QSR) is one of the largest components of the over 440 billion dollar restaurant and food service industry, and is one of the most competitive industries in the world. Sonic most clearly falls under the fast food hamburger category, and competes against multi-national giants McDonalds, Burger King and Wendy's. Sonic's unique drive-in concept and signature items strongly differentiate it from its competitors in the fast food hamburger category; the company offers innovative menu choice and a unique dining experience, somewhat insulating it from competition. Sonic also competes against other QSR concepts. Another huge player in this industry is Yum! Brands, parent company of KFC and Taco Bell. In addition, the Qdoba concept competes in an extremely competitive Mexican segment, with other well know restaurants Chipotle and Baja Fresh, among others.
Wendy's and Arby's have negligible international exposure compared to McDonald's and Yum's where 65% and 50% of sales are generated overseas. Lower international exposure makes Sonic much more dependent on U.S. consumer spending than Yum and McDonald's