Sonic Cut To Sell On McDonald's Aggressive Value Plans

Noting fast-food stocks have recently had a "strong run," citing factors including fund flows out of retail stocks and into restaurants and positive sales trends in the category, Bank of America Merrill Lynch analyst Gregory Francfort raised price targets across the space. However, he downgraded Sonic (SONC) to a sell-equivalent rating, citing the increasing aggressiveness of McDonald's (MCD), which the analyst still views as a top pick.

SELL SONIC: Francfort downgraded Sonic two notches to Underperform from Buy but raised its price target to $30 from $27. The analyst said the downgrade is not a call on the quarter, as the company reports on June 22, and he sees limited downside to Q3 and Q4. However, he notes shares are up 29% since March 21 and Francfort is concerned about 2018 earnings as McDonald's is becoming more aggressive. He believes shares should trade at a discount to peers due to slower unit growth and higher capital intensity.

TOP PICK: Francfort continues to view McDonald's as a top pick and sees further upside from aggressive value plans slated for early 2018 and unit economics. The fast-food chain announced a 55% reimage contribution to support a value menu based around $1, $2 and $3 price points, which could encourage franchisees to co-invest in price aggressiveness, Francfort writes. The analyst said McDonald's is one of the few restaurant companies that can increase franchisee economics through lower price points and can get more aggressive than peers due to higher margins. He added while unit growth for the chain is now negative, McDonald's continues "to screen cheap" on a relative basis compared to other highly franchised restaurant stocks. Francfort raised McDonald's price target to $175 from $165 based on FY18 earnings and reiterated his Buy rating.

OTHERS TO WATCH: Other notable stocks in the fast-food space include Domino's Pizza (DPS), Dunkin' Brands (DNKN), Jack in the Box (JACK), Restaurant Brands International (QSR), Wendy's (WEN) and Yum! Brands (YUM).

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