Wendy’s Win: No Change for McDonald’s, and Fast-Food Sector Concerns

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The Wendy’s Company (NASDAQ: WEN) is proving to be a serious turnaround contender. After double-digit gains after its earnings report, many investors might be tempted to flood back into the stock. In fact, the stock may keep rising whether we have some concerns or not. The problem is that Wendy’s is now getting into stretched valuations, but the real concern is that the valuations of its major fast food and casual dining peers, after looking at McDonald’s Corp. (NYSE: MCD) and its peers being stretched farther than they perhaps should be.

What is driving the enthusiasm here is more than just an earnings beat and more than a successful turnaround. What we have to decipher now is not how this will put Wendy’s on a value quest in 2013 nor even in 2014. Now we have to consider what this burger and fast-food chain can earn in the year 2015.

Wendy’s reported earnings at $0.08 per share, versus consensus estimates of $0.06 from Capital IQ. However, revenues were up less than 1% at $650.5 million, and that was about $8 million short of the estimates. Wendy’s reaffirmed 2013 earnings expectations of $0.20 to $0.22 per share against a consensus of $0.20, and it sees growth of 2% to 3% at the Wendy’s company-operated restaurants.

After an 11% stock price gain to $7.45, we have to at least address the valuations. Wendy’s at the top of the company’s range now trades at more than 30 times this year’s expected earnings. We admit that the 2015 year of a normalized earnings is how investors will evaluate this one. The enthusiasm is that Wendy’s plans to shift its restaurant portfolio with a concentration based on geographic groupings and will take its ownership from about 22% down to about 15% of its entire system after selling around 425 units to franchise operators by the middle of 2014.

So, this puts Wendy’s as a 2015 valuation story. Wendy’s hit a high of $7.60 today, and that gives it a new 52-week range of $4.09 to $7.60. Here is what we ranked the valuation of McDonald’s and peers yesterday:

  • McDonald’s was at 17 times expected earnings, but its near 3% dividend yield tops the group. Our take is that Mickey-D’s needs to see its share price fall back into the low $90s, or even the high $80s, before we would get excited again..
  • Burger King Worldwide Inc. (NYSE: BKW) was trading above what analysts thought it was worth on average. Its private equity sponsors still have a lot of influence here and could keep pressure on the stock. Burger King was trading at 24 times expected 2013 earnings with a paltry 1.3% dividend yield.
  • Jack in the Box Inc. (NASDAQ: JACK) had only 5% implied analyst price target upside, with no dividend and with a balance sheet that remains stretched. It was at 24 times 2013 earnings estimates. Maybe hopes of an unlocking of the Qdoba chain value is the remaining driver.
  • Yum! Brands Inc. (NYSE: YUM) had an issue with us that the stock price just never seemed to get beaten down enough for us to have any interest, based on its damaged brand in China, even if that is on the mend. The 1.9% dividend yield is so-so for food chains, but 23 times expected earnings just feels too steep for any value investor or bargain hunter to chase.
  • Chipotle Mexican Grill Inc. (NYSE: CMG) remains a “growth versus value” investor wild card, and it even used to be a part of the McDonald’s empire. This one pays no dividend as it is still financing growth in new chains as it rapidly tries to catch its earnings and sales growth up to a valuation of 38 times expected earnings.
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