Although the restaurant industry had difficulties last year due to higher food costs and a weaker economic environment, the S&P Restaurants Index increased 17.89% year to date. An interesting fact to note is that this segment has grown by 3% annually over the past 10 years. So let's take a look at two companies in this sector and see which one stands as the most appealing investment opportunity in an industry that employs more than 12 million people, making it America’s second largest employer after the U.S. government.
The Wendy's Company (WEN) is one of the largest fast food restaurants operating with more than 6,000 locations worldwide. The company focuses on quality and therefore higher prices must be charged. However, over the past few years Wendy's has seen a growth decline because customers have had less disposable income and have been switching to other less expensive products. So, do any of the company´s initiatives seem able to reverse this trend?
The “Right Price, Right Size Menu initiative” offers items ranging from 99 cents to $1.99 trying to win back low-price-shopping consumers. Also, a new product introduction like the Pretzel Bacon Cheeseburger at $4.69 is expected to provide good revenues from this quarter. Finally, Wendy's has introduced other innovative products like, the Dave Hot 'n Juicy Burger, the W Burger, and the Double-Patty Baconator. In an attempt to strengthen its international presence, the company decides to expand outside the U.S. because it has an international growth plan. Thecompany stated that “we believe that we have the opportunity to open more than 8,000 Wendy’s restaurants outside of North America”, and more than 3,000 will likely be opened in China, Brazil and Japan.
In terms of valuation, the stock sells at a trailing P/E of 238.1x, trading at a premium compared to an average of 24.7. Analysts’ expectations imply a forward P/E of 30.59. For the second quarter fiscal year 2013, the sales scenario missed the Zacks Consensus Estimate.
One Step Down
Wendy's ranks fourth just ahead Burger King Worldwide Inc. (BKW) which operates and franchises fast food hamburger restaurants, primarily under the Burger King brand worldwide. As of Dec. 31, 2012, the company owned or franchised a total of 12,997 restaurants in 86 countries and U.S. territories, having increased the percentage from 90 to 97% of the system in the past year. This will probably have a positive impact in the return of equity because less capital is required. The company operates in four reporting segments: the U.S. and Canada; Europe, the Middle East and Africa (EMEA); Latin America and the Caribbean; and Asia Pacific.
Burger King wants to remodel 40% of its stores in the U.S. and Canada with its new design by 2015. The new model "draws inspiration from our signature flame-grilled cooking process and incorporates a variety of innovative elements to a backdrop that evokes the industrial look of corrugated metal, brick, wood and concrete." As of Dec. 31, 2012, 19% of the restaurants have the new look and a good improvement was registered in sales with an average increase of 10% to 15% each.
Burger King's stock price is up more than 31% in the last 12 months, outperforming the S&P 500 Index during the same period. This appreciation has driven it to a price level which is relatively expensive compared to the rest of its industry and I believe there is a reduced upside potential in the future.
The profitability of the companies is driven by the ability to meet customer needs. Also, factors such as income levels and level of employment do matter. Wendy's possesses a recognized brand with constant product innovation. On the other hand, branch remodeling conducted by Burger King seems to be working well. According to the analysis in this article I would be long Wendy's and recommend waiting to buy Burger King until the price drops significantly.
Disclosure: Victor Selva holds no position in any stocks mentioned.
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