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Wendy's Outperforms, but It's Already Priced In

By Michael Lewis – Jan 17, 2014 at 11:05AM

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While the industry leader lags, Wendy's is cleaning up in the realm of drive-thrus. The only problem is that the market is well aware.

Like so many consumer-facing industries at the moment, the fast-food world is in transition and under attack by disruptive outside forces -- in this case, fast-casual players like Chipotle and the growing focus on healthy, sustainable food. The legacy fast-food businesses have had to adapt their menus and their service profile -- catering to a more conscious, more discerning customer.

Some have had more success than others. Wendy's (WEN -0.10%) is one that is winning, and its recently released preliminary fourth-quarter results show it. Top-line and store-level sales are growing as the company gives itself a makeover and brings new, relatively exciting menu items to the drive-thru. Unfortunately, the market is aware of Wendy's success and has awarded a sharp premium to shares. Is Wendy's too rich for investors' taste?

Earnings recap
North American company-owned stores (to be specific) posted same-store sales gains of more than 3% in the last quarter of Wendy's' fiscal 2013. On a full-year basis, that number is nearly 2%. Management believes it's menu innovation that is driving the store-level numbers higher. Throughout the year, the company brought to life items such as a pretzel bun cheeseburger. While these products received their fair share of criticism, they were enough to at least get people in the line.

Adjusted EBITDA, as previously guided, dropped 7% in the quarter, though it is set to rise 10% for the full year. Adjusted EPS are set to come in at $0.10-$0.11 for the quarter and $0.29 to $0.30 for the year.

Looking ahead to 2014, management remains bullish on Wendy's prospects. Company stores are set to grow same-store sales by 2%-2.5%, with restaurant margins at 160 bps, adjusted EBITDA in the range of $390 million to $400 million and adjusted EPS $0.34-$0.36 for the year (representing as much as 24% year-over-year earnings growth).

Great success
Management is focusing on selling many of the company-owned stores (throughout 2013, the company sold more than 400), and renovating the ones it does own. Its early efforts are showing plenty of signs of success, so the continued rollout should keep things looking pretty -- as evidenced by the guidance.

The question is valuation. At nearly 25 times the top end of 2014 EPS guidance and more than 26 times the low end, Wendy's is priced more like its fast-casual relatives than a tried-and-true fast-food business. For comparison, industry giant McDonald's trades at roughly 16 times earnings, though investors should note that the company has not witnessed nearly the recent success that Wendy's has. Burger King isn't much less at 24.5 times, but still, this is a lot to pay for a drive-thru burger joint with thousands of locations.

Of the fast-food plays available, Wendy's and Burger King are more appealing than McDonald's, which has seemingly lost its groove lately. But price-conscious investors should tread carefully -- there isn't too much downside protection at these levels.

Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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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