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

Key Points

• There is a money shift coming; the consumer sector is threatened by the rise and break out of the manufacturing space.
• Two restaurant stocks bring the tale of two cities. New and unchartered growth versus steady tested returns.
• Markets - and analysts - have sent their votes, and here is who won.

This isn't the stock market you got used to seeing during the past three years when the FED's stimulus in response to the negative effects of the COVID-19 pandemic sparked a new wave of investor preferences across different sectors and stocks. From 2020 to 2023, it seemed that the only stocks worth buying were technology names with hypergrowth stories. Today, that story changes for better or for worse.

The S&P 500 and the NASDAQ hit new all-time high prices, as virtually every market participant started to price in the effects of a coming FED interest rate cut. However, most expected cuts to come as soon as March 2023, whereas the FedWatch tool at the CME Group NASDAQ: CME points to something more like May of this year. This sudden switch has caused uncertainty, causing investors to seek safer names out there.

For reasons that will become clear in just a bit, names like Wendy’s NASDAQ: WEN could earn all the love from markets and analysts alike within the world of restaurant stocks. As a competitor that used to have all the attention, Shake Shack NYSE: SHAK is now facing a dethroning threat from Wendy’s track record of proven success, but more on that later.

Winds of change

The United States economy has been supported exclusively by the consumer sector, namely consumer discretionary businesses. The ISM manufacturing PMI index has been in consecutive contractions for over a year, yet the U.S. GDP pushed higher. This means that the other half of the nation, the services PMI, carried on the expansion task.

You can see this trend live by following the Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY and its performance against the broader S&P 500 index; up to December of 2023, the consumer had outperformed the market by as much as 5.0%. Today, it is falling behind by roughly 3.0%.

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

Because markets aren’t 100% certain when and if the FED brings the widely anticipated interest rate cuts, hypergrowth stories are likely to take a back seat against other, more established cash-flowing businesses. Here is where the wedge between Shake Shack and Wendy’s begins.

Shake Shack is the newer name that brings exciting news for its shareholders, and who wouldn’t love a stock that is projected to grow its earnings per share by as much as 37.1% in the next twelve months? Impressive by all measures, but particularly so within ‘boring’ restaurant names.

However, markets could soon come to the conclusion that this stock may have no further upside left to it; after all, it does trade at 98.0% of its 52-week high with a price target of $71.8 a share, that’s 9.8% lower than where it trades at today.

 So, any particular reason why these sellers may want to rotate into Wendy’s instead?

Why Wendy’s?

Here is the answer everyone is looking for Because it works. Wendy’s has a much longer track record of success, a business whose financials show an average ROE (return on equity) rate above 20.0% year after year. Shake Shack? It has only broken above even in the past year for the first time.

That could be one of the reasons why analysts are comfortable placing a $23.8 price target on the stock, automatically implying a 23.6% upside from today’s prices. Now, picking Wendy’s can’t be that easy, unless it really is as simple as that.

Markets are willing to pay a premium valuation in this stock, even so above Shake Shack’s price action momentum and massive growth targets. The reason? They trust it to deliver returns even if the consumer sector takes a back seat to the manufacturing or even the industrial names.

The stock is not only trading at 80.0% of its 52-week high, leaving you with a massive gap to catch up to the rest of the sector, but it is also a long way from its all-time high price of nearly $31.0 a 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.

On a price-to-book basis, the ratio that seems to matter the most during a pivot in interest rates from the FED, Wendy’s is head and shoulders above the rest of the industry. Its 11.6x valuation is not only above Shake Shack’s 7.3x but also 35.0% above the industry’s 8.6x average.

Remember the saying “It must be expensive for a reason,” discounted price action, and proposing a safer – better – way to play the consumer sector during his pivot; now you know what the reason may be.