Sonic Earnings Preview: Why Its Already Pricey Shares Should Head Higher

NEW YORK (TheStreet) --  Sonic (SONC) will report fiscal third-quarter earnings results Monday after the closing the bell. The Oklahoma City, Okla.-based fast-food chain continues to do a remarkable job of separating itself from the fierce competition that exists among its sit-in restaurant rivals.

Unlike, say, McDonald's (MCD) , whose restaurants are designed for customers to sit and eat, Sonic's drive-through/drive-in business model relies on customers eating in their cars or taking their food with them. This helps Sonic keep its overhead and labor costs lower since -- for instance -- employees don't have to clean tables or mop dining-area floors after meals.

Moreover, given the smaller amount of space a Sonic needs, it can operate its restaurants with a lower number of employees per shift and considerably lower operational costs like air conditioning and electricity, among other expenses.

The success of this thin model is reflected in Sonic's share price, which is up more than 16% year-to-date, and up more than 45% over the past twelve months, far outpacing the broader averages. Longer term, investors who bought Sonic shares three years ago and and held them have seen their value skyrocket 236%, compared to 57% gains for the S&P 500 (SPX) during that period.

When compared with the valuation of the S&P 500, which trades at a P/E ratio of 21, Sonic stock is not cheap at its current P/E of 32. Still, with the company embracing a mobile strategy to speed up customer orders and cut down even further on labor costs, Sonic's profit margins are poised to expand in the quarters and years ahead.

The 62-year old company is in the midst of what it calls a "multi-layered growth" plan that it expects to complete by 2017, which includes new point-of-sale systems and digitizing its menu boards. To the extent these initiatives can drive higher revenue and boost same-store sales, Sonic shares -- despite being relatively expensive now -- will still be able to produce healthy gains.

For the quarter that ended in May, earnings are projected to climb 20% to 36 cents per share, while revenue is expected to be $163 million, up 7.4%. For the full year ending in August, earnings are projected to climb 29% to $1.09 per share, while revenue is forecast to come in 10% higher at $605 million.

The fact that both quarterly and full-year earnings are projected to climb at almost three times the rate of revenue growth underscores how effective Sonic's efforts to grow its profit margins have been. This explains why, despite its expensive valuation, Sonic still has a consensus buy rating and an average 12-month price target of $38, around 18% higher than its current levels.

Based on all of this, ahead of Monday's third-quarter earnings results, investors should focus less on where Sonic is trading today or how high its P/E might be, and instead recognize the value it's working to create -- value whcih should be reflected in a much higher stock price in the next 12 to 18 months.

This article is commentary by an independent contributor. At the time of publication, the author held no shares in any of the stocks mentioned.

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