When it comes to investing, it can be fun to play games of coulda, shoulda, woulda. Take a wonderful business like McDonald’s Corporation (NYSE:MCD), for example. Over the past 30 years, MCD stock has generated a 12.8% compounded annual return for investors. A $10,000 investment in McDonald’s stock back in 1978 would be worth $966,000 today!
Unfortunately, McDonald’s is unlikely to repeat that feat again. For one, with a market capitalization north of $100 billion, MCD stock is running into the law of large numbers. No, the savvy investor must look for the next McDonald’s.
And we might just have one to watch: Sonic Corp. (NASDAQ:SONC).
Is SONC Stock the Next McDonald’s?
Fast foods are not ideal if you have high cholesterol or are obese, but that doesn’t mean the sector is bad for investors. In fact, the fast food restaurant sector has been booming over the past decade, simply because people love their burgers and fries.
That’s why we saw a staggering upward push in the share price of gourmet burger chain Shake Shack to $96.75 on May 22, trading at a crazy 250x its 2016 earnings and more than nine times its estimated compounded annual growth rate for earnings. These were not realistic numbers. Traders made money, but those believing it was a long-term play were burned.
The market leader in the fast food restaurant sector is now up for grabs after the E. coli threat at Chipotle Mexican Grill, Inc. (NYSE:CMG) that has wiped out 27% of the company’s market value. I still like the long-term thesis with CMG, but the drastic decline in same-restaurant sales to the low single-digits from solid double-digits is concerning. I would wait out for a recovery of this key metric before feasting on this stock.
The majority of you probably think McDonald’s as the king of fast foods. It probably still is, but the share price is also at a 10-year high, so the easy profits have come and gone for MCD stockholders. I would be more inclined to sell put options on MCD to establish an entry point than buy the stock outright.
Why Hedge Funds Like This Small-Cap Fast Food Play
A small-cap fast food restaurant stock that can return better percentage returns in the medium-term versus that of MCD or CMG stock is Sonic Corp. The stock is trading around the midpoint of its 52-week range and has been rallying off its range low of $22.72, set in September 2015. I wouldn’t be surprised to see a recovery in SONC stock of its range high at $36.73 from March if the company can deliver better results.
Chart courtesy of www.StockCharts.com
With the price weakness, we have been seeing the vultures (aka hedge fund managers) swirl around Sonic, looking for a potential bounce. Big institutional investors include Vanguard Group, Inc. (7.41%), Chilton Investment Company, LLC (6.32%), BlackRock Fund Advisors (6.22%), and Price (T.Rowe) Associates Inc. (4.66%). (Source: “Sonic Corp. Major Holders,” Yahoo! Finance, last accessed December 7, 2015.)
I’m sure many of you have driven by or perhaps turned into one of the more than 3,500 drive-ins across the country. Maybe it’s nostalgic for some of you, but driving in and getting served by attendants on rollerskates seems kind of cool.
From burgers and chicken sandwiches to fries and milkshakes, Sonic has a big following, serving more than three million diners each day.
I like the company’s business model format, with most of its risk assumed by franchisees, as about 90% of the restaurants are not company-owned.
A look at the numbers shows higher revenue and gross profits in FY14 and FY15, after a small relapse in FY13.
Impressive was the key system same-store sales increased 7.3% in FY15 and marked the fifth consecutive fiscal year for growth. These metrics are far better than what you are seeing at McDonald’s or Chipotle.
Sonic is also buying back its shares, which is an effective use of capital on the share price weakness. The company has repurchased 15.1 million shares during the past three years.
Also watch the large short position of 7.03 million shares, or 11.73% of the float, as of November 13. If I’m right, we could see the short sellers inevitably running to cover.
Technically, the downside risk is around $20.00 to $25.00, while the upside is $30.00 to $40.00.