Wendy’s vs Shake Shack: Out with the new, in with the old?

This is not the stock market you’re used to seeing over the past three years, when Fed stimulus in response to the adverse effects of the COVID-19 pandemic triggered a new wave of investor preferences across multiple sectors and stocks. From 2020 to 2023, it seemed like the only stocks worth buying were tech names with histories of hypergrowth. Today that story changes for better or for worse.

The S&P 500 and NASDAQ hit new all-time highs as virtually all market participants began pricing in the effects of an impending interest rate cut by the Fed. However, most expected the cuts to occur as early as March 2023, while the FedWatch tool at ECM Group NASDAQ: ECM indicates something more similar to May this year. This sudden change has caused uncertainty, pushing investors to look for safer names in the market.

For reasons that will become clear shortly, names like Wendy NASDAQ: WED could earn all the love from the markets and analysts in the world of restaurant stocks. As a competitor who had all the attention, Shake Shack NYSE: SHAK is now facing a threat of dethronement from Wendy’s proven success, but more on that later.

Wind of change

The US economy has been supported exclusively by the consumer sector, i.e. by discretionary consumption activities. The ISM PMI manufacturing index has been in continuous contraction for over a year, but US GDP has risen. This means that the other half of the nation, the services PMI, has continued expansion activity.

You can see this trend live by following the SPDR fund for selected consumer discretionary sectors NYSEARCA: XLY and its performance relative to the broader S&P 500 Index; through December 2023, the consumer had outperformed the market by up to 5.0%. Today its lag is approximately 3.0%.

Analysts at The Goldman Sachs Group NYSE:GS see that 2024 could bring a turning point in the manufacturing sector, which would take away attention from services and consumer stocks, a trend that is starting to form in the performance of the aforementioned ETF. Now, not all consumer titles are created equal.

Since markets aren’t 100% sure when and if the Fed will deliver the widely expected interest rate cuts, hypergrowth stories are likely to take a backseat to other more established cash flow assets. This is where the wedge between Shake Shack and Wendy’s begins.

Shake Shack is the latest name bringing exciting news for its shareholders, and who wouldn’t love a stock that’s expected to grow its earnings per share by up to 37.1% over the next twelve months? Impressive in all respects, but especially with the “boring” restaurant names.

However, markets may soon come to the conclusion that this stock may no longer have any upside room; after all, it’s trading 98.0% of its 52-week high with a price target of $71.8 per share, which is 9.8% lower than where it’s trading today.

So, any particular reasons why these sellers might want to switch to Wendy’s?

Why Wendy’s?

Here is the answer everyone is looking for. Why it works. Wendy’s has a much longer track record of success, a company whose financials show an average return on equity (ROE) rate of more than 20.0% year after year. Shake Shack? He also managed to pass the level in the last year for the first time.

This may be one reason why analysts feel comfortable setting a $23.8 price target on the stock, which automatically implies an upside of 23.6% from today’s prices. Now, choosing Wendy’s can’t be that easy, unless it really is that simple.

Markets are willing to pay a premium valuation for this stock, even if it is higher than Shake Shack’s price action momentum and massive growth targets. The reason? They have confidence that it can generate returns even if the consumer sector takes a back seat to manufacturing or even industrial names.

The stock is not only trading at 80.0% of its 52-week high, leaving you with a huge gap to catch up with the rest of the sector, but it is also a long way off its all-time high of nearly $31.0 per month. share. Markets are willing to look past Shake Shack’s 37.1% EPS growth and pay a premium for Wendy’s 12.1% projection for this year.

In terms of price/book value, the ratio that seems to matter most during an interest rate shift by the Fed, Wendy’s is a cut above the rest of the industry. Its 11.6x valuation is not only higher than Shake Shack’s 7.3x, but also 35.0% higher than the industry average of 8.6x.

Remember the saying “It has to be expensive for a reason”, the discount pricing action and the proposition of a safer – better – way to play the consumer sector during its turning point; now you know what the reason could be.

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