Investors Have a Beef with Wendy's

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Apparently there are only so many Pretzel Bacon Cheeseburgers diners are willing to eat.

After Wendy's (NASDAQ: WEN  ) reported third-quarter results that sharply narrowed losses -- and on an adjusted basis turned a profit that beat analyst expectations -- investors tossed the burger joint's stock into the wastebasket. Shares fell 11% on disappointing sales numbers.

Like McDonald's (NYSE: MCD  ) and Burger King Worldwide (UNKNOWN: BKW.DL  ) , the restaurant chain is introducing new items to its menu in a bid to attract new customers amid an explosion of fast-food and casual-dining eateries.

Whereas McDonald's has found itself challenged by customers who seemingly don't want to move off the dollar menu for higher-priced fare, Wendy's has straddled the different tastes of its customers, offering both value meals and premium sandwiches. Along with upgrading its restaurants to cater more to the fast-growing casual dining sector, Wendy's is in the midst of a turnaround that is bearing fruit, its latest quarterly results notwithstanding. 

Along with the new cheeseburger mentioned above, which has been selling well, the restaurant introduced a Pretzel Pub Chicken Sandwich last month that's also been well received. But not every new offering is likely to be a success for Wendy's and its rivals. Wendy's whiffed with the Flatbread Grilled Chicken Sandwich, which dragged down overall sales.

We're seeing innovation all across the sector. McDonald's has introduced everything from steak and eggs on muffins to multiperson meal boxes, while Burger King is putting its previously limited-time-only Big King sandwich on the permanent menu. And Red Robin Gourmet Burgers (NASDAQ: RRGB  ) is introducing a burger developed by Chef Laurent Tourondel that will feature Black Angus beef topped with premium ingredients. Interestingly, rising beef prices recently caused McDonald's to kill off its line of Angus beef burgers. (While it's often thought of as premium thanks to marketing by the American Angus Association, Angus beef is really no different than beef from any other breed of cow.)

French fries are also a fertile new ground for competition, with Sonic, Burger King, and even Yum! Brands coming out with new ways to serve up the humble potato.

Despite the shock and horror Wendy's investors served after the earnings release, there's a lot to like about what it showed. The sale of hundreds of stores to franchisees will continue to provide the company with a more predictable cash flow and higher margins. Meanwhile, same-store sales rose 3.2% (albeit below expectations of 3.9%), and Wendy's raised its full-year earnings guidance to $0.25 per share, from earlier forecasts of $0.20-$0.22 per share.

The fact that the stock plunged as sharply as it did suggests it had gotten well ahead of itself on expectations of a straight line run-up, which I've previously noted was pricing like it was a fancy restaurant instead of a burger chain. 

I still like this burger joint, but even with the pullback, Wendy's is still richly valued. At nearly 29 times expected earnings, it's on par with Red Robin and Biglari Holdings, which runs the Steak 'n' Shake chain. Still, there might be better deals had at Burger King and Yum!, which go for around 20 times estimates, and now that McDonald's trades at nearly half the valuation assigned Wendy's, it might be the best value for the money on the menu.

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  • Report this Comment On November 13, 2013, at 4:20 PM, ghstflame wrote:

    Looking at wendy's (and RAD's) P/E is not really looking at the business. At this point forward P/E is permissible, and price/sales is ideal. Both companies are in the middle of massive turn around and earnings will catch up with share price in the next 2-3 years and obviously when compared to the trailing 12 months earnings are going to look crazy over valued.

    RAD will be past $10 in the next 18 months, and WEN is moving on to $12 in the next year. $15 price target on RAD for the next 3 years, and $20 on WEN for the same period.

    Long RAD @ $2.20 and WEN @ $5.20

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