Here's Why Investors Should Steer Clear of Sonic (SONC) Now

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Sonic Corp.SONC has been recording substandard performance and disappointing investors, of late. In fact, shares of this Zacks Rank #4 (Sell) company have declined more than 17% in the last year, as against the industry 's gain of 5.3%.

Also, the Zacks Consensus Estimate for current-quarter earnings has seen seven negative revisionsfor the last two months versus none in the opposite direction. This, in turn, has led to a 2.3% decline in the consensus estimate trend.

Lackluster Earnings Growth: Sonic has historical (3-5 years) earnings per share (EPS) growth rate of a negative 4.2% compared with the industry's average of 5.7%. Investors should also focus on projected growth where the company's EPS is still estimated to decline 4.1% year over year. During the same time, the industry is expected to record an average EPS growth rate of 3.9%.

Earnings growth is often an indication of strong prospects (and stock price gains) ahead, for the company in question and is thus one of the most important factors to consider. Evidently, Sonic falls very weak on this front according to current estimations.

Weak ROE: Sonic's trailing 12-month return on equity (ROE) undercuts its growth potential. Notably, the company has delivered a ROE of negative 81.1%, which compares unfavorably with the ROE of 7.8% for the industry, reflecting the fact that it is less efficient in using shareholders' funds.

Industry Headwinds Pressurizing Sales: Over the last few quarters, the U.S. restaurant space has not been too enticing. Despite economic growth, somewhat lower energy prices and higher income, consumers increased their spending only modestly on dining out, which resulted in low consumption. This is because, along with wage growth, inflation is also on the rise that translates to lower real income and thus less disposable income. The situation has taken a worse turn, thanks to higher health care costs and tightened credit availability in the United States.

Moreover, as consumers demand high-quality products at lower prices, it is pushing grocery stores to decrease their food prices in order to remain competitive. This is resulting in a bigger gap between food-at-home and food-away-from-home indices.

Consequently, same-store sales growth has been dull in a difficult sales environment. Traffic too has been weak. In fact, the second quarter of 2017 marked the sixth consecutive quarter of negative comp sales for the restaurant industry as a whole, thereby continuing the somber mood. Sonic is no exception to the trend and resultantly, the company's sales have come under pressure.

In fact, per the company's fiscal third-quarter conference call, management expects Sonic's same-store sales to decline approximately 2.5% in fiscal 2017. Furthermore, as the macroeconomic environment continues to impact results, the company expects adjusted EPS for fiscal 2017 to decline in the range of 2-5%.

In fact, the Zacks Consensus Estimate for the current fiscal year projects a sales decline of 20.9% from the prior year.

Rising Costs to Weigh on Margins: Sonic continues to shoulder higher costs in the form of wage rate increases (particularly in Colorado markets) and commodity inflation. These are likely to weigh on the company's margins. As a result, the company has reduced its owned drive-in margin guidance to 15.3% from its previous expectation of 15.5-16%.

Stocks to Consider

Investors interested in the restaurants space can consider some better-ranked stocks instead. These include Del Taco Restaurants, Inc. TACO , Bravo Brio Restaurant Group, Inc. BBRG and Papa John's International, Inc. PZZA carrying a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

In the trailing four quarters, Del Taco, Bravo Brio and Papa John's pulled off an average positive earnings surprise of 3.61%, 28.27% and 5.1%, respectively.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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