Fast-food chains are making a formidable attempt at adapting to shifting consumer tastes. For decades, a solid cheeseburger at a low price had been enough to drive the rapid expansion of the businesses throughout the United States and overseas, but now it appears that fast eaters want more. With new products such as a Pretzel Bacon Cheeseburger, and health-oriented flatbread sandwiches, The Wendy's Company (WEN +1.46%) is proving to be a formidable competitor to the long-reigning number one chain, McDonald's (MCD +1.43%). The stock is feeling full as well, up more than 35% in 12 months. The question now is, can the stock still move higher as management continues its renovation, or has this opportunity passed?
Refreshed
New menu items aren't the only signs of change at Wendy's, and certainly not the only elements that analysts predict will show big results come the company's earnings release next week.
Wendy's has taken substantial efforts to boost its comparable, and ultimately, bottom-line sales. The company has cut unprofitable operations, such as breakfast service for certain franchises, while saving in areas like beverages -- where management recently negotiated more favorable contracts with two suppliers. Similar to McDonald's recent efforts to boost store sales (which include late night breakfasts, healthier choices), Wendy's has emphasized its value menu, while simultaneously pushing high-priced premium items, like the above-mentioned Pretzel Bacon Burger. Back at headquarters, the company refinanced its debt at more favorable rates, resulting in increased full-year guidance.
Adjusted EPS guidance represents an 18%-29% premium over the prior year's numbers, lending some comfort to the chain's seemingly rich valuation.
Even with its improving operating performance and smart strategic decisions from management, is Wendy's still a buy at these levels?
Valuation
At the top end of guidance, an EPS of $0.22, Wendy's is currently trading just under 30 times. For reference, McDonald's trades at 16 times forward earnings, and number three chain Burger King sits in between the two at 22 times forward earnings. Using EV/EBITDA, though, paints a different picture. Wendy's is the least expensive, at 10.44x, with McDonald's hovering around 11.5x, and Burger King by far the richest, at 14.45x.
Wendy's balance sheet improvements have made it more appealing when viewing the business from the perspective of a private owner, even if it appears investors are paying up big time for earnings. For this type of business, EV/EBITDA might be a better indicator of value, as the metric stabilizes capital structure (when comparing to other businesses) and provides more clarity as to the condition of the operating business.
In conclusion, Wendy's is not a bargain at these levels, but may still provide the most upside potential among the top three fast food chains.
