Courtesy of Dr. Paul Price of Market Shadows
Juicy Burgers – Inedible Valuation
Momentum players are hot for shares of second-tier burger and fries maker, Wendy’s (WEN). The stock has been on fire in 2013 rising from under $5 to close Thursday at $8.62. Should we pile into the stock?
KeyBanc Capital market analyst Christopher O'Cull said we should when he boosted Wendy's from "Underweight” to "Hold." That's essentially upgrading WEN from Sell to Neutral as it hit a new multi-year high.
Is there any big news to justify the move? Not unless you think launching a pretzel-bun, bacon cheeseburger justifies a 60% gain in market cap. Current EPS estimates for 2013 are around $0.23, putting yesterday’s close at 37.5x this year’s estimate.
Wendy’s isn’t cheap on 2014 expectations of $0.27 per share either. What makes WEN worth almost 32x forward earnings when industry leader McDonald’s (MCD) trades for under 16 times its 2014 estimate?
Wendy’s shareholders have been disappointed for years. The shares fell 88% from $22 in late 2006 to $2.60 (during 2008). I think WEN deserved that poor long-term performance. Wendy's posted $0.30 in 2007 EPS and $0.17 for the full year 2012.
Over the long term WEN has underperformed 90% of all stocks in Value Line’s 1700 company main research universe.
Regular readers of my columns know that I rarely buy options or sell naked calls. (Although I do sell puts, see Market Shadows' Virtual Put Selling Portfolio.) The excessive valuation of WEN led me to break my own rules. I bought some Feb. 2014 $10 puts this morning for $1.80 per share while also selling a matching number of Feb. 2014 $9 calls. I own no Wendy’s shares.
To make money on the puts on expiration date, I need WEN to be trading below $8.20. Any drop to below that point starts making me money on a dollar for dollar basis. A drop back to $5 would give me a big gain.
The naked calls at the $9 strike will be winners as long as WEN remains below $9.60 on expiration date. My maximum gain on this segment of my trade is the 60-cents per share I took in upon sale of the calls.
If Wendy’s retreats quickly, I may close out both halves of this transaction early.
Disclosure: Long WEN Feb. 2014 $10 puts, short WEN Feb. 2014 $9 calls.
