Shares of The Wendy’s Company (NASDAQ:WEN) traded higher at the open on Monday, after investing paper Barron’s wrote that shares would rally 40% in the coming months. Barron’s argues that the company’s transformative efforts will allow it to trade at a higher multiple. But does that argument make sense?
“New” fast food vs old fast food
In recent years, a key trend has begun to develop in the fast food business. Two tiers have emerged: an old guard of established players, and a new group of rising stars.
The old guard is embodied by a company like McDonald’s Corporation (NYSE:MCD) — a company that has been serving burgers and fries for decades. It would also be fair to include McDonald’s classic competitors like Burger King Worldwide Inc (NYSE:BKW), Yum! Brands, Inc. (NYSE:YUM)’ Taco Bell and KFC, Arby’s, and of course, Wendy’s.
The young upstarts include Chipotle Mexican Grill, Inc. (NYSE:CMG), Panera Bread Co (NASDAQ:PNRA), Five Guys and Qdoba (owned by Jack in the Box Inc. (NASDAQ:JACK) — a member of the old guard, more on that later).
Both camps have some fundamental similarities. They both offer relatively inexpensive food in a fast and casual manner. But the members of new fast food have focused on higher-quality menu items, making their food more akin to traditional restaurant dining than the standard, greasy bag fare old fast food is famous for.
Wendy’s feels threatened
Wendy’s isn’t taking the threat to its business lying down.
The company’s CMO, Craig Bahner, told Nation Restaurant News in October that the company “couldn’t stay stagnant” as it faced “the new standard” embodied by “Chipotle, Panera, [and] Five Guys.”
Bahner proclaimed that, not only would Wendy’s have to catch up to these competitors, but would have to “leapfrog” them, stating that food brands are grown “to be viable not for a quarter, but for years.”
But others recognize this threat as well
As Barron’s notes, Wendy’s has taken great steps to revitalize its brand, including remodeling stores and adding new items to its menu. Wendy’s will even unveil a new logo in March. But Wendy’s isn’t the only one doing this. Virtually all members of the old fast food dynasties have done the same.
Burger King, for example, has been in the process of radically remaking itself for about the past year. After ditching its creepy King mascot, the company literally beefed up its menu with new burgers, chicken strips, fruit smoothies and sweet potato fries.
Since the company returned to the public markets in June of 2012 (after a period of private equity ownership) shares have performed admirably, and are up about 9%.
Taco Bell’s strategy has led Einhorn to short Chipotle
Hedge fund manager David Einhorn told investors that he was shorting Chipotle at an investment conference back in October. Besides its (in Einhorn’s opinion) absurd valuation, Einhorn targeted Chipotle due to his belief that Taco Bell would pressure the rising fast food star.
Over the summer of 2012, Taco Bell introduced a number of upscale “Cantina” items, including a Cantina bowl — a menu item very similar to Chipotle’s burrito bowl. Einhorn made the argument that this would be the beginning of the end for Chipotle, as the established Taco Bell “ate [Chipotle’s] lunch.”
Jack in the Box owns Qdoba
Somewhat ironically, at the same conference Einhorn said he was shorting Chipotle, a young hedge fund analyst argued that shares of Jack in the Box were poised to rally.
Ryan Fusaro won a contest to present his investment thesis: JACK is very undervalued, and shares should trade at $57.
Part of Fusaro’s argument was based on one of Jack in the Box’s subsidiaries — in this case, Qdoba. For those not familiar, Qdoba would be a near-direct competitor to Chipotle, offering high-quality burritos at a reasonable price. With its exposure to the new fast food market in Qdoba, Fusaro argued, Jack in the Box was a buy.
A crowded trade
Rather than flying under the radar, Wendy’s transformation is less of a business revolution than necessary maintenance.
Most of the old fast food names recognize that their industry is changing, and have taken steps to bring their business into a new era. While Burger King is bolstering its menu, Taco Bell is trying to challenge Chipotle. Meanwhile, Jack in the Box owns a chain that would be considered new fast food.
A successful Wendy’s transformation might propel shares to new heights, but it certainly isn’t a sure thing. By Wendy’s own admission, competition in the fast food industry is increasing at an alarming pace: Fast food consumers today would scoff at the food offered just 10 years ago.
In this new world of higher standards, Wendy’s efforts to remake itself might be critical just to keep its current place in the broader fast food pantheon.
On the bright side, it certainly shows that Wendy’s management isn’t afraid to be aggressive. Unfortunately, so is everyone else.
The article Wendy’s to Win Emerging Fast Food Battle? originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
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