Taking Another Tour With This Fast Food Company
Abir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you are an investor hungry for gains, Wendy's (NASDAQ: WEN) may be able to fill your appetite. This is because, since my last positive article about this giant in January of this year, the company's stock has outperformed that of major competitors such as McDonald's (NYSE: MCD), Yum! Brands (NYSE: YUM), Burger King Worldwide (NYSE: BKW), and Chipotle Mexican Grill (NYSE: CMG).
To continue this great performance, Wendy's is undertaking a number of initiatives. But at the same time, there lie a number of uncertainties and headwinds, which could become a negative issue for the company's shares in 2013.
Fundamentals and valuations
A table is being provided below that will compare Wendy's major valuation measures and fundamental metrics to that of its competitors, and the S&P 500 Index.
Source: Thomson Reuters, Capital IQ, SEC filings.
It can be observed from the above table that Wendy's still has one of the most attractive valuations. A negative factor is that the company has the lowest EBITDA margin, but this is already factored in its lowest EV/EBITDA ratio of 9.1. On a price-to-book value and price-to-sales basis, Wendy's trades below its peers and the S&P 500 Index. Importantly, based on price-to-CFO, Wendy's is also undervalued, underscoring the company's cash generating capability.
In this competitive fast food industry, all the players are forced to constantly reinvent themselves, and offer new menu items to hold their valued customers. The largest effort that Wendy's undertook in the past year is its image activation campaign, that include inside remodeling (tier 1, 2 and 3) as well as structural and outside improvements (tier 1). The company renovated 48 franchise stores in 2012 under the program, and plans to renovate an additional 100 (although more than 100 applications were received) in 2013, with 20% of system wide locations renovated by the end of 2015.
As per estimation, tier 1, the most expensive renovation improves sales by as much as 25%. Tier 2 and 3 image activations will be tested this month. So, there lies an uncertainty about its success comparable to that of tier 1. Upon completion of each image activation, the company pays an incentive. So in this quarter of 2013, estimated expenses for renovation will be $10 million.
This second largest burger chain is constantly introducing new upscale menu items (Dave's Hot 'N Juicy, Baconator, Asiago Ranch Chicken Club, and others) followed by a recently launched value offering called "right price right size menu". The company also introduced a new logo, packaged with inspiring graphics, more stylish uniforms, and bolder ads. All this, combined with an increased advertising budget and focus on social media, should contribute to the company's 2013 projected EBITDA in the range of $350-$360 million, compared to EBITDA of $333 million in 2012.
Wendy's major competitors are also undertaking similar initiatives, which are being provided in the table below.
The fast food industry, including Wendy's, will have to deal with higher commodity and employee costs. Wendy's management estimates that 40% of the food cost are in beef and chicken equally. Due to higher corn prices and increase in demand, these two commodities are likely to continue their price increase in 2013. Further, employment expenses will likely rise as the Affordable Healthcare for America Act starts to be phased in.
The fast food industry is labor intensive, and headwinds include an immigration reform requiring stricter proof of eligibility to work. However, Wendy's plans to counter these negatives by improving efficiencies, closing unprofitable locations, and discontinuing breakfast to improve margins. Most companies in the fast food industry increase prices as a last resort, and it will not be a surprise if we see synchronized price increases this year. All this brings uncertainty, which makes investing in fast food retailers riskier.
To wrap things up
Based on a number of metrics, although Wendy's is cheaper than those of its competitors, it still carries significant risks. This is because food inflation and employment costs could hurt the company more severely than expected. On the other hand, its image activation campaign (tier 2 and 3) is still untested. This year will be important for Wendy's, as the company is undertaking a number of initiatives.
It’s important for investors to make speculative bets on companies' strategy changes in order to achieve high returns, and have a well-diversified portfolio. Over the past six months, the company’s shares have risen significantly. It could be safer if investors stay on the sidelines, and see how the rest of the year unfolds for Wendy's. The stock could be a great long-term investment, if the company is successful with its initiatives, and is able to overcome the challenges.
Abir Karmakar 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. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!