Wendy's Rebranding Impresses, but the Stock Value Doesn't

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At the recent investor presentation in June, Wendy’s (NASDAQ: WEN) gushed about all the positives of brand reimaging, bringing amazing benefits to updated stores. In fact, some of the initially updated stores saw a 25% increase in revenue that came from higher traffic, as prices haven’t been raised.

Wendy’s is a well-established QSR burger brand with around 6,500 restaurants, of which around 22% are company-owned. Anybody that grew up eating at Wendy’s knows that the brand has become extremely stale, and the restaurants are very outdated and unappealing to dine at. Hence the company recently undertook a brand reimage program that has seen extremely positive benefits in the first year.

Unfortunately, the company competes in an ultra-competitive sector where industry leader McDonald’s (NYSE: MCD) has already completed a refresh and Burger King Worldwide (NYSE: BKW) is in the refresh process as well. Unfortunately for new investors, the stock has risen sharply to multi-year highs, likely on the back of the store improvements.

Image Activation

The company is calling the brand refresh Image Reactivation. It includes an updated logo, expanded menus, new advertisements, new beverage dispensers, and most importantly an updated store layout and look. As the picture below shows, the company has a much more modern and sleek appearance:

<img alt="" src="http://g.fool.com/editorial/images/58616/screen-shot-2013-07-17-at-111532-am_large.png" />

Also worth noting is the focus on three different tiers or levels of updates costing anywhere from a full redesign at $750,000 to a less intrusive and affordable update at $375,000. With 6,500 stores, it will take years for a complete refresh of every location. The company is only targeting 200 locations in 2013, and combined with new stores and updates from 2011 and 2012, Wendy’s will only have 314 stores on the Image Activation design by the end of this year. The plan is to roughly double the updated stores in both 2014 and 2015 though that will leave over 5,000 stores remaining at the end of 2015.

Sustainable performance

Wendy’s stores already provided a solid $1.5 million in average unit volume, but the Image Activation stores have seen an impressive first year sales lift of $300,000 or roughly 20%. The slide below shows the sustaining lift over the 24-month period:

<img alt="" src="http://g.fool.com/editorial/images/58616/screen-shot-2013-07-17-at-111513-am_large.png" />

Naturally the company has limited updated stores to use for analysis, so the market will have to project whether the refresh will impact all stores in a similar manner or if this update will lose momentum over time. Conversely, the refresh could gather steam as consumers become more familiar with the new look and identify that as an updated location and possibly chose it over a Burger King or McDonald's.

Valuation

The valuation proposition is where the story gets complex. The stock has already had a large lift even without producing much in the way of bottom-line results. The stock trades at nearly 30 times forward earnings with analysts only forecasting 15% growth per year.

Burger King trades at 22 times forward earnings with earnings forecast to grow at 16% per year. Industry leader McDonald’s trades at 16 times forward earnings with roughly 8.5% growth expected.

The only argument investors can make is that Wendy’s will accelerate growth into the refresh in 2014 and beyond. Maybe the same will occur for Burger King, though the sector appears overvalued considering the general lack of volume growth in the sector. Margins can only be improved so much in the group to justify these multiples of forward earnings, especially considering one company will have to take market share from another one.

Bottom line

While the reimage at Wendy’s was long overdue, investors appear ahead of the plan for now. The sector, as well, appears overvalued considering the lack of general growth in volumes and revenue. With the growth potential from the reimaged stores, Wendy’s could be a compelling stock on a pullback in the future. Without a pullback, it is difficult to pay over $6 for a stock expected to only earn around $0.23 per share next year.

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Mark Holder 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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