Fast-food restaurants have stood the test of time, proving that no matter the economic environment, they remain noncyclical in nature. And while many might prove to be good long-term investments, there are three reasons that Wendy's (NASDAQ:WEN) is better than its peers McDonald's (NYSE:MCD) and Burger King Worldwide (NYSE:BKW).
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With Wendy's, Burger King, and McDonald's, there really is no need to explain their businesses. All three are national chains with distinguished products: Burger King has the Whopper; McDonald's is famous for the Big Mac; and Wendy's has a selection of old-fashioned hamburgers. However, as an investment, the three don't look equal at all.
In the five years prior to 2012, shares of McDonald's soared more than 125%, not losing any value during the recession. While global expansion was in part responsible, the real reason for the gains revolved around strong growth in the high-margin McCafe business. McDonald's found a hit and then rolled out new flavors and sizes, and gave consumers an array of choices surrounding these beverages.
Now, Wendy's is doing the same with its pretzel burger, and neither McDonald's nor Burger King appears to have such a product. Wendy's pretzel burger is its best-selling new product in more than a decade, and this newfound growth driver should give investors a reason to be optimistic, as Wendy's rolls its pretzel concept on to other sandwiches.
Wendy's same-store-sales growth goes hand-in-hand with its pretzel burger. Back in August, following the launch of the pretzel burger, many analysts boosted their same-store-sales growth estimates to 5.5% from 3% for 2013.
In Wendy's last quarter, the company saw same-store-sales growth of 3.2%, suggesting the holiday season could be strong for the restaurant chain.
When assessing industries such as retail or restaurants, same-store sales are often the best metric of company growth and success. These are companies that can rapidly expand to increase revenue, but with expansion comes higher costs, and same-store-sales growth indicates that more consumers are buying more food per store. This ultimately drives margin growth.
In comparison, McDonald's has 0% to 1% same-store growth, and Burger King is even worse, barely breaking even. Hence, Wendy's is growing the fastest.
While Wendy's has the hottest product in fast food and is growing the fastest, it might not be a good investment if the stock is significantly more expensive than its peers. Thankfully, it's not. In fact, Wendy's is actually cheaper!
Wendy's trades at 30 times next year's earnings, which might appear pricey at first glance. Yet a closer look reveals that Wendy's trades at just 1.35 times sales and has an operating margin of 7.9%. In comparison, McDonald's trades at 3.5 times sales and Burger King at 5.6 times sales.
Surprisingly, both Burger King and McDonald's trade at a cheaper forward-earnings ratio, at 21 and 16 times forward P/E, respectively. The reason is that both have higher operating margins, McDonald's at 30% and Burger King at 44.5%. Both companies have been aggressive in cost-cutting; Burger King saw operating costs decline 64% in its last quarter. On the other hand, Wendy's is investing in growth.
With Wendy's growth in existing stores, there is reason to believe that its 7.9% operating margin will rise and its operations should generally improve. If so, earnings will increase, making its discount to sales a strong sign of value.
As of now, Wendy's is not operating with the same level of efficiency as its peers. While many view this as a negative, I see it as a bonus, as value investors seek operations that are able to improve. In the case of Burger King and McDonald's, both companies' margins are maxed and there isn't much room for growth. Therefore, what is the investment upside?
With Wendy's we can clearly identify an investment opportunity, see value, a growth driver, and room for operational improvement -- none of which I can find in Burger King or McDonald's. Hence, Wendy's looks to be the clear winner in this fast-food battle.
Fool contributor Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.