by Lawrence Meyers | May 23, 2012 7:30 am
Sometimes I get a craving for a fast-food burger. It may not even matter which brand — I just pick whichever chain has the closest store. That’s when it hit me: While I may not distinguish between fast-food burgers, there’s probably a big distinction between the stocks of Jack in the Box (NASDAQ:JACK), Wendy’s (NYSE:WEN) and McDonald’s (NYSE:MCD).
I wrote about McDonald’s last autumn and mentioned that while the company is about as fantastic an operation as one can find and a perfect example of a monolithic, popular American business, the stock was vastly overpriced.
Not much has changed. The price is in the same place, falling back to $91 after a run to $102. Although MCD is a classic Peter Lynch stalwart — with its 10% annualized growth, billions in cash, lots of low-cost debt and generous provider of free cash flow — I just can’t get my arms around its 17x multiple. I’m all for giving a company a premium, but a 70% premium?
Even if you add in the 3.1% dividend, it’s still way too expensive.
So how do you play this stock? I’d say if you literally plan to hold it for 30 years, buy it, but wait for the inevitable market plunge, where you may pick it up at a 10% discount. Or use my covered-call strategy for great companies, which works irrespective of stock price.
Wendy’s presents an interesting proposition. Back in March, I wrote that it was a speculative buy at $5, and the stock sits at $4.41. The company has begun a turnaround plan, which didn’t yield great results in Q1. Some of this has to do with higher beef prices cutting into margins, but that isn’t why comparable store sales only rose 0.7%, revenue eked out a 2% increase and operating profit fell 25%.
Wendy’s success going forward is going to hinge on the execution of this turnaround, which includes smart moves like adding breakfast to the menu. I’m not sure if redesigning the restaurants themselves is a good move. It’s capital-intensive, and I think people come for the quick meal, not the ambience.
The company is making some small steps in its capital structure — using a new credit facility to replace some 10% senior notes, saving $25 million in interest. With Wendy’s, I think my position remains the same. It’s a speculative buy with possibly big upside. However, the company isn’t going bankrupt, so shorting it makes little sense.
I haven’t looked at Jack in the Box before today. But it also appears to be at an inflection point. The company has about $470 million in debt, whose 4% blended interest is serviced through operating cash flow.
The problem with Jack is that he isn’t generating free cash flow, and hasn’t for some time. Yes, the company makes a solid profit every year, but that’s as far as it goes. Its 2,200 store base, plus 600 Qdoba Mexican Grill restaurants, have established a foothold in American culture — much of it thanks to its clever commercials.
At least Jack seems to be having a better time of it than Wendy’s. Comps were up 4.2%, although revenue was basically flat. The company has decided to sell its stores to franchisees, so while restaurant sales were down 9.5%, distribution and franchised restaurant revenue saw huge gains — 15% and 21%, respectively.
This turnaround seems to be gaining traction. Growth should restart in 2013 after falling this year. But once again, you’re looking at a stock, now priced at $24.19 with a 17x multiple. How can Jack have the same multiple as McDonald’s, when McDonald’s has zillions in free cash flow and more than 10 times the number of restaurants?
I would stay away because Jack is too pricey, especially since it’s a turnaround play. Sell it if you have it.
Lawrence Meyers does not own shares in any company mentioned.
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