** OPTION TRADE: Buy
the MAR 17 2017 25.000 put at approximately $1.20. Place a pre-determined sell
Note: No protective
stop losses added -- but if you wish to do so make it $0.50.
by Ian Harvey
Tuesday, January 03, 2017
Restaurants faced several challenges in 2016 as concerns about a "restaurant recession" swept through the industry during the second half of the year. According to conventional wisdom, a combination of food deflation, overexpansion, and even the distraction of the election have caused comparable sales growth across the industry to slow rapidly. Rising labor costs have also been a challenge as states hike their minimum wages and the labor market tightens. Many chains have seen labor costs go up in the process, taking a bite out of profits.
And, Sonic Corporation (NASDAQ:SONC), a company that operates and franchises one of the largest chain of drive-in restaurants in the United States, will report its fiscal first-quarter results on January 4, and is likely to be a victim. The company will post its quarterly numbers after the market close, with the consensus calling for earnings of $0.22 per share. During the same period last year the company had earnings of $0.24.
Sonic's Q4 report was absolutely horrendous. The margin growth had an unceremonious death as comps took their toll. The stock eventually fell to just $21.
Sales are expected to fall 17% this year, including 10% for Q1. That, of course, is due primarily to the refranchising effort but also because Sonic is struggling with comps. The refranchising effort will boost margins over time but the damage to sales is palpable.
The stock has fallen 16.8% during 2016.
Sonic Corp. has a 50-day moving average of $27.11 and a 200-day moving average of $26.97. Sonic Corp. has a 12-month low of $21.12 and a 12-month high of $36.34. The company has a market cap of $1237.96 billion, a P/E ratio of 20.55 and a beta of 1.47.
Factors to Consider
Earnings are supposed to be slightly lower in Q1 than last year, owing to the franchise mix shift crushing revenue but boosting margins.
Sonic is a former high-flyer in terms of growth and the reason the stock was hammered after the Q4 report is because comps were solidly negative. Q1 is a potential fresh start but also keep in mind that the slowdown in comps in the past fiscal year didn't take place until later. That means that despite the lowered expectations, comps against last year's Q1 are still going to be fairly tough. That doesn't necessarily seem built into the share price at this point as it remains at $27 because - as we know - lower comps produce lower margins. There are a lot of moving pieces for Sonic right now, and while the refranchising effort should boost consolidated margins, the worry is about unit-level profitability. Lower input costs are great but labor rates continue to rise as well, and in Q1, it is believed that there is going to see a tough comp and that will drive margins to disappoint.
The problem is that the stock has already rebounded from its lows despite the fact that we don't yet have any evidence that it should. Q1 is going to be weak unless some miracle took place and it appears that the stock has come too far as it is now going for 22 times this year's earnings. Given that EPS is supposed to contract slightly this year that seems a dear price to pay. The refranchising effort is going to take time, and for now, the bull case at $27 is not viable.
Sonic Corp.‘s stock had its “hold” rating reiterated by Deutsche Bank AG in a research report issued to clients and investors on Sunday. They currently have a $25.00 price target on the stock. Deutsche Bank AG’s price target would suggest a potential downside of 5.70% from the company’s previous close.
Several other equities research analysts have also commented on the stock…..
Three equities research analysts have rated the stock with a sell rating, seven have issued a hold rating and five have given a buy rating to the company’s stock. The stock currently has a consensus rating of “Hold” and an average target price of $27.00.
Harvey’s Options Volatility Indicator
With the stock having rallied back to $27, it looks like a sell into earnings. The risk that Sonic somehow figured out comps after Q4's flop is lower than the risk of paying 22 times earnings for a stock with contracting EPS.
Therefore, based on the facts above, and Harvey’s Options Volatility Indicator, the following option trade is recommended…..
** OPTION TRADE: Buy the MAR 17 2017 25.000 put at approximately $1.20. Place a pre-determined sell at $2.40.
Note: No protective stop losses added -- but if you wish to do so make it $0.50.
”Success is simple. Do what's right, the right way, at the right time.”
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Options traders win because they are successful.