Fast Food Stocks: How a Laggard Suddenly Looks Tasty

YCharts

Not all fast food chains are created equal. Just take a look at the divergent experiences of the venerable Wendy’s (WEN), which just announced earnings that beat analysts’ estimates, while flashy newbie Chipotle Mexican Grill (CMG) warned investors that higher-than-expected food costs will lead to a disappointing fourth quarter.

Indeed, with all the hubbub surrounding some of Wendy’s better-known rivals, like McDonald’s (MCD), the controversy about Yum! Brands’ (YUM) Chinese operations and Chipotle’s fall from grace, Wendy’s risks being overlooked altogether. That wouldn’t be fair: although the burger chain’s revenue growth has lagged some of those higher-profile rivals, it doesn’t have high expectations baked into its stock price, and it is rolling out an array of new promotions that it believes will help it compete more effectively with McDonald’s and Burger King (BKW).

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Still, even without an improvement in same store sales in the fourth quarter (sales at company-owned restaurants open at least 15 months fell 0.2% and slipped 0.6% at franchised operations) Wendy’s posted better than-expected earnings for the period, signaling that its turnaround is on target. Moreover, the company’s managers reiterated that they expect Wendy’s to earn from 18 cents to 20 cents a share in the 2013 fiscal year, slightly better than the analysts’ consensus forecast of 17 cents a share.

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Another reason to favor Wendy’s is the company’s newly-increased dividend; the company just doubled the quarterly payout to 4 cents per share, and the dividend yield is about 3%. On top of that, management announced a $100 million buyback program to expire in late December 2013. To the extent that the share repurchase program chips away at the number of shares outstanding, that will help ensure the dividend yield remains close to its current levels if the stock price edges higher.

A key question for Wendy’s is one that can’t be quantified: its ability to craft new marketing programs that will attract budget conscious customers who still want healthy offerings. Consumers are finicky, and in the face of the kind of higher food costs that caused Chipotle to issue its earnings warning, this may be a downside risk. On the other hand, Wendy’s has plenty of room to expand its market footprint. For instance, McDonald’s has already established itself as a breakfast destination and rolled out an array of cheap dollar menu items. Wendy’s still can capture a lot of upside from similar initiatives.

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In the process, they could end up eating Chipotle’s lunch. The former market darling has fallen off its pedestal, even though – in contrast to Wendy’s – the company still expects to report revenue growth and same store sales growth that was positive in the fourth quarter, while that at Wendy’s was flat to down slightly. But Chipotle has been a high-expectations stock, one that now is failing to deliver on its pledge of great earnings growth. While same-store sales climbed 3.8% in the fourth quarter, that is a slower pace than the 4.8% pace set in the third quarter. And the company itself now says its fourth-quarter earnings likely will be only $1.92 to $1.97 a share, compared to analysts’ estimates of $2.09. Using high-quality ingredients may be a great marketing tool, but it doesn’t leave Chipotle with much room to respond to higher costs by raising its prices in the current value-conscious environment.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.


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