Wendy's Has Become Even Pricier After Earnings; Time to Sell?

Wendy's looks overpriced in comparison with competitors such as Burger King and Chipotle Mexican Grill. Is its share price justified by its growth potential, or is now the right time to take profits?

Jan 17, 2014 at 10:10AM

Wendy's (NASDAQ:WEN), the iconic U.S. burger chain, has had a stellar run over the last 12 months, soaring more than 80% and more than tripling the S&P's gain for the same period. In fact, the stock has quite easily outperformed shares of its major competitors such as Burger King Worldwide (NYSE:BKW). However, the stock's impressive rise has left it trading at a very steep multiple, even in comparison with fast-casual competitor Chipotle Mexican Grill (NYSE:CMG), and a hefty premium versus the industry and the broader market. As such, it may be time to start taking profits.

Latest report
The maker of square burgers delivered a very solid fourth-quarter preliminary report and it looks to be capping off the year in style. Adjusted earnings per share for Wendy's should be in the range of $0.10-$0.11, whereas analysts expected EPS of around $0.06. The range comes because of uncertainty surrounding the tax closing procedures for last year.

Revenue wasn't quite as impressive. The company expects a 6% drop to $592.4 million for the fourth quarter, which will miss the $605.7 million consensus. On the other hand, the company gave very upbeat 2014 guidance. Wendy's now expects earnings per share of around $0.34-$0.36 for the full year, which thrashed analysts' expectations of around $0.29 in EPS. Comp-store sales accelerated in comparison to last year, up 1.9% versus last year's 1.6%. Wendy's shares popped following the report, and they were up nearly 6.5% by the end of Monday trading. 

Wendy's has increasingly been facing competition from fast-casual restaurants such as Chipotle Mexican Grill. As a result, it has been working on upgrading some of its menu items, such as offering higher-quality bread options. This seems to be paying off. The fourth-quarter earnings strength was boosted in part by the popularity of the chain's new Pretzel Bacon Cheeseburger and the Pretzel Pub Chicken sandwich.

Rivals: Burger King and Chipotle
Key competitor Burger King seems to be employing a different strategy, as it has chosen to focus on its value menu, which has now been renamed the "King Deals Value Menu." Under this system, the burger chain offers a number of burgers and sandwiches for $1 each for a limited time. Burger King's dedication to its budget offerings seems to be paying off, as third-quarter EPS rose around 35% year over year to $0.23.

Chipotle, on the other hand, aims for a more upscale experience, essentially offering a casual-dining alternative to chains such as Taco Bell. This "fast-casual" dining concept is the fastest-growing segment of the restaurant industry, which partly explains the stock's meteoric rise over the last few years.

The company delivered a solid third-quarter report, with comps up around 6% and net income rising by around 15%. Additionally, the company has plenty of avenues left for growth. Chipotle just announced a move into pizza with its Pizzeria Locale concept, and with most foreign markets still untapped, it could also look at expanding geographically. With increasing demand for GMO-free and healthier foods, Chipotle also seems well positioned to capitalize on industry shifts.

Valuations and metrics                                                                                                             Looking at P/E figures, Wendy's is clearly the most expensive of the restaurant stocks mentioned here, which is somewhat curious considering its competitors' strong performances. It currently trades at a hefty 94.5 times trailing earnings and 31 times forward earnings, which is high by almost any measure and seems to be unsupported by growth figures. Going forward for example, Wendy's' expected 3-5 year growth rate is only around 1%, far below the 16% industry average and Chipotle's massive 33%. Additionally, comp store sales growth at Wendy's is somewhat uninspiring, especially compared to Chipotle. In essence, Wendy's doesn't seem to be growing the top or bottom line as quickly as the competition, but is nevertheless trading at a steep premium to the industry. 

Regarding competitor valuations, Burger King trades at 38 times trailing earnings and Chipotle trades at 53.66, both still expensive but considerably less so than Wendy's. To be fair, the restaurant industry as a whole seems overpriced at the moment, with an average trailing P/E of around 30, but more than three times the industry average seems a bit rich. Additionally, Wendy's operating margin of 8% looks quite weak in comparison to major rivals, as does the return on equity of less than 2%.

The bottom line
Wendy's recently came out with a solid earnings report, which clearly pleased investors. However, the stock is now trading at an even higher premium than before and it looks rather overpriced in comparison with major competitors and the industry as a whole. While the company is growing, the figures do not seem to justify the sky-high multiples the stock trades at, which leads me to believe it might be time to take profits on Wendy's.

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Fool contributor Daniel James has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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.

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