Monday, November 21, 2011

Take a Bite Out of Wendy's Stock; Skip Jack in the Box

During a period of slow economic growth do people buy more fast food? If so, is there an investment opportunity in buying stock in the Quick Service Restaurant (QSR) companies that serve it? A comparison of the earnings of Jack in the Box (NYSE: JACK) -- that reports its third quarter results Monday -- and Wendy's (NYSE: WEN) reveals some answers. 

The QSR market totaled $166 billion and was expected to barely budge in 2011 at a 1% rate to $167.7 billion in 2011, according to a March 2011 report from The report noted that thanks to the economic downturn, there was significant pent up demand -- 40% of consumers were "not dining out or using takeout as often as they would like." And the report speculated that by unleashing that demand, QSR industry revenues would recover rapidly as the economy recovered. 

The biggest player in the industry is McDonald's (NYSE: MCD), according to QSR. In 2010 its sales totaled $32.4 billion -- earning it QSR's top rank -- based in part on the strength of its very high $2.4 million in annual sales per store. Wendy's 2010 sales of $8.3 billion gave it 24% of McDonald's revenues or $1.4 million per store -- and QSR's #4 rank. And Jack in the Box's 2010 sales of $2.9 billion gave it 9% of McDonald's revenues or $1.3 million per store -- and QSR's #15 rank.

In 2010, Wendy's implemented new menu ideas and cut a lagging brand. Among the new ideas were "adding Garden Sensations Salads to the menu and offering a Pair 2 Menu that gave customers a chance to choose among 35 salad combinations for $5," according to QSR. Wendy's also added Natural Cut Fries with Sea Salt -- tossing out its old fries altogether -- and it dumped its Arby’s unit in the first half of 2011.

These changes have contributed to good results. In the third quarter of 2011, Wendy's adjusted EPS of 5 cents a share were a penny ahead of the Zacks Consensus Estimate. Wendy’s total revenue grew 1.8% to $611.4 million in the quarter. This was due to 3% growth in company-owned restaurants and 1.7% more franchise revenues. Its average transaction was up due to "menu improvements [and] brand repositioning," according to Zacks.

Meanwhile, Jack in the Box is good at advertising, it added new items to its menu in 2010, and it added low-priced items. According to QSR, Jack in the Box won "another gold Effie Award for its Jack campaign." Its new menu items included "Breakfast Pita, Pastrami Grilled Sandwich, Really Big Chicken Sandwich, and a Grilled Chicken Sandwich," wrote QSR. And it added low-priced options such as paying $3 for "a Hamburger Deluxe, a small fountain drink, and french fries."

This approach has not been enough to boost its results though. On Monday, before its report, the average analyst estimate was 41 cents a share, up 2.5% the year before. But this positive expectation follows two quarters in a row of disappointing results -- in its fiscal third quarter its reported EPS of 38 cents was 2 cents a share short of expectations and in its second quarter the company missed by 9 cents.

So here's what the investment choice between Wendy's and Jack in the Box boils down to:
  • Wendy's: Shrinking, narrow margins; cheap stock. Wendy's sales have fallen 4.6% in the past 12 months to $2.66 billion, while net income has plunged, down 223% to $2.9 million – yielding a miniscule 0.1% net profit margin. Its PEG of 0.44 (where a PEG of 1.0 is considered fairly priced) is inexpensive on a forward P/E of 22.7 and expected earnings growth of 52% to $0.23 in 2012.
  • Jack in the Box: shrinking, narrow margins; expensive stock. Jack in the Box's sales have dropped 7% in the past 12 months to $2.3 billion while its net income declined 46.4% to $62 million -- yielding a narrow net margin of 2.75%. Its PEG of 1.43 is expensive on a P/E of 17.1 and expected earnings growth of 12% to $1.63 in fiscal year 2012.
Wendy's looks like the winner in this fast food faceoff. But that success depends heavily on a big turnaround in 2012. Jack in the Box looks like it's in pretty rough shape but a better than expected result in its third quarter report could change that.


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