Shares of Wendy's (NASDAQ:WEN) have experienced a flat performance over the past 12 months by returning only 2.7%. The stock also has a lackluster medium to long term performance history. Over the past 3 and 5 years, WEN has declined 13.69% and 67.60%, respectively. Despite trading at very close to its 52-week low of $4.29, WEN's valuations are hard to be justified by the company's fundamentals.
In this article, I will illustrate some of the rationales supporting my bearish view on the stock.
My comparable value analysis includes a set of fast-food restaurant chains based in the U.S. The estimated stock value is determined by equally weighting the valuations calculated by the three peer average multiples - EV/EBITDA, EV/FCF, and P/E, as they are the most relevant valuation measures for established companies such as WEN.
The following four paragraphs are based on the table shown below:
In terms of growth potential, WEN's top-line and EBITDA are likely to rise by below-average growth rates. Especially for EBITDA, the 2-year CAGR of 2.4% is even significantly lower than Domino's (NYSE:DPZ) 4.9%, which is the second lowest in the group. WEN's EPS growth, however, is much better than the peer average.
Accounting for the earnings growth, WEN is trading at the highest PEG at 1.7x, suggesting the stock is likely overpriced to the earnings growth prospects.
On the profitability side, WEN substantially underperforms the peer group. All of its profitability margins are lower than the averages, and the company is barely making a positive net income margin at 1.0%, compared to a solid group average of 7.6%.
Speaking of liquidity, WEN is the only firm in the group that generates negative free cash flow. It carries an average level of debt. Investors should note that WEN's interest coverage ratio is dangerously low at just 1.6x, compared to the peer average of 24.3x. This is primarily because the firm's margins are extremely low relative to the leverage it assumes. Even with a mounting debt load of 771.1% to total capitalization, DPZ is still able to maintain a higher interest coverage ratio at 2.6x. However, one good spot is that WEN's current and quick ratios appear to be healthy.
As such, the stock valuations should warrant a discount to account for the weak financials. Nonetheless, the current price of $4.54 per share actually implies an average of 31% valuation premium over the three peer average multiples, which appears to be lofty and groundless (see below) in my view.
If only compared with Yum! Brands (NYSE:YUM), WEN is still valued at an average of 20% premium over YUM's three trading multiples (see below). However, YUM outperforms WEN in almost all of the financial metrics except for EPS growth rate as well as current and quick ratios. Furthermore, YUM's operations and growth primarily rely on the fast-growing emerging markets and the firm also enjoys a stronger brand equity globally, further suggesting that WEN's heightened valuations are not justified.
Moreover, WEN's estimated revenue, EBITDA, and EPS have experienced multiple downward revisions over the past 18 months, indicating market expectations are deteriorating (see below).
Lastly, WEN's LTM FCF has been slowly decreasing over time (see below), and there has been no sign of turnaround by now.
Bottom line, WEN's relatively weak fundamentals are likely not able to support the current valuations. However, I do not suggest shorting the stock either as WEN's NTM EV/Sales and NTM P/S (although they are less relevant) remain much lower than the peer group averages (1.1x and 0.7x vs. 1.5x and 1.3x), and a possible expansion of those ratio due to some positive corporate developments would impose substantial risk to short sellers. Nevertheless, the more relevant valuation multiples discussed above indeed suggest very little margin of safety for the investment. As such, I encourage investors avoiding this stock.
All comparable analysis tables are created by author, estimated financial chart and LTM FCF chart are sourced from Capital IQ, and all financial data is sourced from Capital IQ and Morningstar.
Disclosure: I am short WEN.