Sonic has been showing supersonic returns to investors.
The drive-thru chain reported quarterly earnings of $0.07 per share with net income at $4.1 million, a 3% increase for the quarter ending in February. What's more, same-store sales were up 1.4% compard to this time last year.
But here's where there could be warning signs: the company's revenues of $109.7 million were actually down 1.3% for the quarter compared to last year. That's despite Sonic's shift in advertising spending into more cable rather than local TV spots over the past year. So, while profits are up, revenues are down.
Meanwhile, Sonic's stock is soaring. While fast food behemoth McDonald's is down 2% for the past twelve months, Sonic is up 98%. That also trounces Burger King's 35% and Wendy's 59% gains over that time period as well as celebrated upstart Buffalo Wild Wings' 74%.
Though Sonic may be cutting costs, one place it is spending money is in the stock market. Specifically, the company is buying back a lot of its own stock – 6% last year alone about 4% is expected to be bought this year.
Portfolio manager Chad Morganlander of Stifel's Washington Crossing Advisors believes that while he likes a lot about Sonic, he doesn't believe it's a good investment.
"It has great management, it's a great company, and [it] possesses a unique business model," says Morganlander. "But, I believe that the valuation is in nosebleed territory. So, in fact, I would not be a buyer of Sonic at this point."
Though earnings are expected to grow roughly 16%, the stock is trading at about 28 times this year's expected earnings and 24 times next year's expected earnings.
"I just don't think that this company has a lot of upside to it," says Morganlander. "And also, you have to keep an eye on the balance sheet. The debt burden in there is quite lofty.
As of this most recent quarter, Sonic's total net debt is $422 million. Roughly one-third of the company's $92.2 million in operating income is used to pay interest. Despite the company using some of that debt to buy back shares, that's not enough to get Morganlander into the stock.
I still think, though, that it's somewhat toppy," says Morganlander. "I would look towards McDonald's as perhaps a safer alternative."
Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, believes there may be some upside potential in the short-term but not for investors looking out to the future.
"This is one of those classic situations where we're short-term bullish," says Ross, "but longer-term, this is not where you want to be investing."
Ross notes the stock was in a reverse head and shoulders formation that began in December, generally a bullish pattern. After testing the 200-day moving average in a 20% drop back in January, the stock subsequently broke out above its neckline resistance.
However, Ross sees the longer-term chart showing a key resistance level. And, with the stock trading around $23 per share on Tuesday, that level is close at hand.
"You're running into resistance up around the $25 level," says Ross. "That brings us back to those all-time highs established back in 2007/2008, up around $25. You can see why on the trading side, there's a little more momentum to the upside. But, longer-term, the reward is just not commensurate with the risk here. So, I would not be committing that type of longer-term capital."
To see the full discussion on Sonic with Morganlander on the fundamentals and Ross on the technicals, watch the video above.