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Introduction

Wendy's (WEN) offers some of the best investment opportunity based on its growth opportunity and the relatively low valuation of its stock. Also, Wendy's benefits from being the smallest of the major nationwide QSR (Quick Service Restaurants) thus allowing the company greater avenues for growth and flexibility. Finally, Wendy's image activation campaign (started in 2011) is progressing slowly but steadily, its ability to offer innovative value and premium products, and its tight grip on costs could provide upside surprises in the future.

Quarterly performance

Below is a table summarizing the latest quarterly performance for Wendy's, Chipotle Mexican Grill (CMG), Burger King (BKW), McDonald's (MCD), and Yum! Brands (YUM).

WEN

CMG

BKW

MCD

YUM

Sales increase comparable stores qoq

0.8%

1.0%

(1.4%)

(1.0%)

(3.0%)

Operating margin

3.7%

16.5%

15.0%

29.5%

19.2%

Operating margin change qoq

0.2%

0.9%

3.4%

(0.5%)

(4.3%)

Net new restaurants

-16

48

22

85

294

Franchised restaurants

78.2%

0.0%

89.7%

80.9%

77.5%

Total restaurants

6,544

1,458

12,534

34,565

37,140

Qoq - quarter over quarter

As seen from the above table, Wendy's is decreasing its restaurants while increasing comparable-store sales. The only company able to match Wendy's increase in same-store sales is Chipotle, which is a relatively new company. Of the five companies, McDonald's and Yum! appear to be growing their restaurant numbers while margins are declining and same-store sales are decreasing. The new initiatives driving Wendy's same-store sales growth are the recent launch of the right price, right size menu offerings that include six items at $0.99 and eight items between $1.29 and $1.99. Also, Wendy's has successfully launched new items and most recently it started selling a flatbread grilled chicken sandwich and frosty cones to increase snacking traffic to its restaurants. Improvements in sales are also driven by Wendy's image activation campaign. During 2013, it plans to open 200 'reimages' (basically a complete remodel of the store and its organization) up from 48 in 2012. Also, Wendy's surprisingly reduced its G&A expenses by $7 million (or about 10% qoq) in the quarter, signifying its ability to reduce and control costs.

Some of Chipotle's initiatives during the past quarter that affected sales positively include the option of catering for groups of over 20 people and the introduction of sofritas (burritos with tofu) in 107 restaurants in northern California. In addition, Chipotle is focused on human resources, despite the federal government's expanding its investigation into the company's hiring practices. The company has a restaurant mentoring program that allows adjacent restaurants to mentor each other. Also, it is focused on managing peak hours by:

  • having back up positions,

  • being fully-staffed, and

  • not training new hires during rush hour.

The big three, Burger King, McDonald's, and YUM! are also innovating and offering value items. Burger King launched a turkey burger, 10 new coffee items, and expanded its delivery in two more major U.S. cities (Denver and Phoenix). Similarly, McDonald's recently launched premium McWraps that were first introduced in Europe. On the non-menu side, the company introduced a new packaging design and QR codes on its cups to improve customer input.

Finally, Yum! is launching at its Taco Bell restaurants Cool Ranch Doritos Locos Tacos hoping to capitalize even further on the success of Doritos Locos Tacos and is expanding its sales layers by launching delivery, breakfasts and 24-hour restaurants. While the company's Chinese operations were negatively affected by issues with its hog suppliers and more recently with avian flu concerns, China remains one of the largest opportunities for Yum! The company launched an effort to work only with modern chicken houses there, a new aggressive quality assurance program and major news around value and innovation. Also, Yum! is on track to open 1,600 new restaurants there in 2012 and 2013 mostly in tier 2 and 3 cities, which have lower costs and higher margins. Other emerging markets should also contribute to Yum!'s future results including India where the company plans to open 150 new restaurants , Turkey, Russia and South Africa. However, a higher than expected food inflation in the second half of 2013 could put more pressure on Yum! as well as Burger King and McDonald's, which have much larger costs of food and emphasis on value menus.

Fundamentals and valuations

WEN

CMG

BKW

MCD

YUM

Price-to-earnings (PE) '13

28.9

34.3

25.1

17.2

23.4

PE-to-growth

3.0

1.7

1.8

1.8

1.0

EBITDA margin

14.0%

20.1%

38.7%

35.6%

20.4%

EV-to-EBITDA

9.7

19.1

14.7

11.1

12.6

Dividend yield

2.7%

nil.

1.2%

3.1%

1.8%

Price-to-sales

0.9

4.0

4.1

3.6

2.4

Price-to-CFO

9.7

22.1

28.4

14.1

14.6

Beta

0.9

0.6

n/a

0.3

0.6

1-year total return

34%

(8%)

34%

12%

14%

Source: Thomson Reuters, CapitalIQ, author's calculations; EBITDA - earnings before interest, tax, depreciation, and amortization; EV - enterprise value; CFO - cash flow from operations.

As seen from the table above, Wendy's has the most attractive valuation based on a number of measures including EV-to-EBITDA, price-to-sales, and price-to-CFO. It has the lowest EBITDA margin, which highlights the importance of scale at QSRs. Also, based on PE-to-growth, the company seems overvalued, however, long-term growth is most difficult to estimate and prone to the largest margin of error. It is important to note that cash flow is one of the most important measures when valuing QSRs and Wendy's clearly has the lowest price-to-CFO among the peer group. Its price to earnings is higher than those of Burger King, McDonald's and Yum! and lower than that of Chipotle. It seems like Wendy's has the best balance between growth and value (Chipotle being the most growth dependent and McDonald's the most value oriented stock). Also, Wendy's as well as the other companies in the group have authorized share repurchasing plans, which could further boost performance per share in the future.

Conclusion

Wendy's is successfully growing its sales with new menu offerings and restaurant renovations. At the same time, the company's net growth of new restaurants is decreasing and it is managing costs well. For example, it recently ceased offering breakfast in all of its restaurants in the U.S. in order to improve its margins. The shares are cheaper than those of Chipotle as well as Burger King, McDonald's and Yum!, based on a number of measures. Factoring in all these different metrics, seems like Wendy's offers the most attractive valuation when accounting for growth. Investors looking to invest in the QSR industry should consider Wendy's despite its smaller size and focus primarily on North America.

My previous articles about Wendy's:

Mar. '13 - Revisiting Wendy's

Dec. '12 - Wendy's Continues To Execute Well

Sep. '12 - 3 Reasons Wendy's Stock Offers A Cut Above Investment Opportunity

Source: Wendy's Mix Of Growth And Value Is A Cut Above