Wendy’s Stock: Lower Q3 Earnings Could Hurt

  • Analysts expect Wendy’s third-quarter earnings to decline.
  • A lower third-quarter EPS could hurt Wendy’s stock.
  • High valuation is also a concern.

Wendy’s (WEN) will announce its third-quarter earnings on Wednesday. We think that the stock could take a hit due to lower third-quarter earnings and a high valuation. Wendy’s faces a tough YoY (year-over-year) comparison on the earnings front, which could limit growth in the third quarter. Notably, the company’s bottom line rose about 89% during the third quarter of 2018. Benefits from the lower tax rate drove Wendy’s third-quarter earnings last year.

Besides tough comps, Wendy’s investment to expand its breakfast menu nationwide will likely weigh on its bottom line in the third quarter. In September, the company announced that it would invest $20 million to take its breakfast menu nationwide. Management lowered the 2019 EPS outlook due to the one-time investment.

Wendy’s valuation doesn’t look attractive as the EPS growth slows down. The stock trades at a forward PE ratio of 32.8x, which is above the peer group average of 25.0x. Meanwhile, the company’s EPS will likely fall in 2019. Also, the earnings could remain subdued in the first three quarters of 2020. However, easy comparisons in the second half of 2020 might spur growth.

Last month, Cowen downgraded Wendy’s stock due to pressure on the earnings and cash flows from breakfast menu expansion. Cowen downgraded the stock from “outperform” to “market perform.” Meanwhile, J.P. Morgan reduced the target price to $22 from $23.

Analysts’ expectations

Analysts expect Wendy’s to post revenues of $434.49 million in the third quarter, which implies YoY growth of 8.5%. The company’s top line will likely gain due to higher revenues from company-operated restaurants and sustained momentum in its comps. Also, higher franchise royalty revenues could support sales.

Wendy’s company-operated restaurant margins could take a hit from commodity inflation and higher labor costs. Also, investments in digital initiatives could pressure the margins. However, pricing will likely support Wendy’s margins.

Analysts expect Wendy’s to post an adjusted EPS of $0.15, which implies a YoY decline of about 12%. Higher taxes and tough comps could drag the company’s third-quarter earnings down.

Will Wendy’s stock face the same fate as its peers?

Chipotle (CMG), Shake Shack (SHAK), and McDonald’s (MCD) shares witnessed selling pressure after their third-quarter earnings.

Chipotle posted strong sales and earnings growth. The company’s sales and earnings grew at a stellar pace and beat analysts’ expectations. However, an expected delay in new store openings irked investors. Chipotle’s shares fell 12% after its third-quarter earnings on October 22.

Meanwhile, Shake Shack posted its third-quarter results after the markets closed on Monday. The company missed analysts’ sales estimates. However, Shake Shack’s sales continued to grow at a strong pace due to new store openings. Management blamed the transition to Grubhub for volatility and lowered the fiscal comps outlook. Notably, the stock fell more than 16% in the after-hours of trade.

While Chipotle and Shake Shack sustained the growth momentum, McDonald’s (MCD) had disappointing third-quarter results. The company missed analysts’ expectations on the sales and earnings front. Also, the CEO’s sudden departure pressured McDonald’s stock. Notably, the shares have fallen 10% since the company reported its third-quarter results on October 22.

Wendy’s stock has risen 31.7% YTD as of Monday.