Wendy’s
Every time we look at the restaurant space, we are surprised to see at how small Wendy’s (click ticker for report: ) market capitalization is. Shares have been stuck in neutral for the past year, even though we think the company is in a much better competitive position. Unlike McDonald’s (click ticker for report: ), which has distinctly made itself the preeminent value chain, Wendy’s has mostly held the line on pricing. Wendy’s “Right Price, Right Size” menu has helped, but overall the company has lost traffic.
If economic conditions improve, we think Wendy’s could be a beneficiary versus its peers because it has maintained its quality reputation. While the levels of price differences in the burger space (Wendy’s/McDonald’s/Burger King) has never been too enormous, Wendy’s is often perceived as pricier, in our view. Additionally, the firm is doing significant re-imaging across its store base, while introducing new products.
On the profitability side, the firm has experimented, but mostly failed with breakfast. Keeping successful breakfast restaurants serving, while allowing others to close, could boost overall profitability.
Looking ahead, the firm anticipates same-store sales to increase 2%-3% in 2013, up from 1.6% during 2012. The company will also open 40-45 net new stores internationally and anticipates gaining 20 to 50 basis points of operating margin expansion. The future certainly looks better, but we continue to believe shares are fairly valued.
McDonald’s
McDonald’s has been in a shaky situation for the past several quarters, as same-store sales growth has stalled out, leaving earnings expansion challenged. Shares have bounced between the mid-$80’s to the $100 range, in spite of (arguably) declining fundamentals.
Same-store sales appear to be slowly recovering, and we think March will be a solid month in the US with the Shamrock Shake driving strong traffic. McDonald’s success over the past few years has been astonishing, but it’s running out of tricks like expanding breakfast and hours to drive same-store sales growth. We think the Golden Arches’ success during the Great Recession may have created unrealistic expectations for consumers going forward. The emphasis on the dollar menu created a consumer who seeks value at McDonald’s and is even hesitant to order other, higher-margin items. Convincing its consumers to trade up may prove difficult—even if they have more dollars in their pockets.
The firm has a compelling dividend growth profile, but we think shares are fairly valued, and we would need to see a substantial pullback before becoming interested in them.
Chipotle
Chipotle (click ticker for report: ) has been a rollercoaster ride during the past year. Recent results suggest that the company needs to raise prices to maintain margins. If the US economic recovery continues, we think consumers will more readily stomach a price increase than if lackluster growth continues.
With intense competition from Yum! Brands’ (click ticker for report: ) Taco Bell and even Jack’s (click ticker for report: ) Qdoba, we think stronger growth could prevent customers from trading down. Trading down has been a real obstacle since Taco Bell introduced the Doritos Locos and the Cantina Bell menu, in our view.
Although stronger growth in the back half of 2013 certainly helps Chipotle, we continue to have no interest in owning shares at this time. The company’s new store openings aren’t likely to be as productive as past store openings, and we think a price increase could hurt traffic. We continue to monitor the name as a put option candidate in the portfolio of our Best Ideas Newsletter.
Yum!
Although China steals much of the spotlight around Yum!—as it well should—Taco Bell experienced wonderful performance through the course of 2012, as same-store sales jumped 8%. Taco Bell in particular markets itself well, and the Doritos Locos tacos reached blockbuster status, becoming a “must-try” in the ranks of the McRib and Shamrock Shake.
Pizza Hut and KFC did not experience such strong growth, with same-store sales at both firms growing only 3% year-over-year at each. We don’t see a reason why either segment would experience a greater-than-average lift from improving economic conditions. Yum! shares look fairly valued.
Jack In The Box
Jack In The Box has quietly established the nation’s number two burrito chain in Qdoba, but like Chipotle, its sales growth has suffered under intense competition from Taco Bell. Same-store sales growth slowed from 3.8% during the first quarter of fiscal year 2012 to 1% during the first quarter of 2013, but the restaurant format continues to add stores at a tepid face, with a mix of franchise versus company-owned of about 50%.
Most believe Qdoba will eventually be spun off, but we see no reason why Jack should do that. The core Jack In The Box concept has struggled, though same-store-sales growth came in at 1.9% during the quarter. The chain is going through a refranchising effort, which could improve returns on invested capital and give the company more money to invest into Qdoba. Jack In The Box could get a nice lift from an economic recovery, especially since its current efforts seem to be luring customers away from McDonald’s. Shares look a bit too pricey for our taste at this time.