The quick service restaurant industry has been revealing some distinctive results the past months. We’ve been watching for some time the turns this industry has given as the “new QSR” or Fast-Casual restaurants are growing while consumers’ preferences are shifting towards healthier menu options and organic food, as well as more friendly environments. Big chains such as Wendy’s (WEN), McDonald’s (MCD) of Burger King Worldwide (BKW) are competing now not only against each other, but also against fast-casual restaurants such as Panera Bread (PNRA) or Chipotle Mexican Grill (CMG).
Wendy's is one of the big players in the quick-service restaurant industry in the U.S., with more than 6,500 units in 27 countries as of Dec 2013. The firm operates as a franchisor through its subsidiary Wendy’s International Inc. and its restaurants offer a menu of hamburgers, chicken breast sandwiches, wraps, chili, baked and French fried potatoes, salads, drinks and Frosty desserts. After years of holding the third position among QSRs, Wendy’s recently toppled Burger King and is currently the second-largest hamburger chain behind McDonald's.
This diverging restaurant industry context has shown particular results, but Wendy’s managed to develop a strategy to improve traffic, revitalizing its brand, introducing new products such as the pretzel bun sandwiches, and launching a refreshed marketing campaign, all while maintaining the company's reputation for quality food. This limited-time item strategy which granted them a big time during 2013 is still to reveal its potential regarding this year’s performance for Wendy’s.
Fourth-quarter results were bittersweet for Wendy’s, as EPS of $0.11 beat consensus estimate by 10.0%, and revenue (unaudited) was $592.4 million, dropping 6% year-over-year, due to the franchised stores. The reduction in the number of company-owned restaurants was pulled out as a part of their system optimization initiative, looking forward to a transition towards a franchises system. Wendy’s reported a 3.1% comps increase at company-owned restaurants, and 2.8% growth at US franchised-restaurants. The management sustains this success was possible because of the popularity the new limited-edition products Pretzel Pub Chicken Sandwich and Bacon Portabella Melt on Brioche had, which reflected on those figures. Nevertheless, the fact that the limited-product offers made such a difference on the comps makes us think these results might be rather unstable.
Company’s full-year forecast shows a comps growth of 2.5% to 3.5% and EPS of $0.34 to $0.36. Although these figures are looking a bit overly optimistic, comps from early 2013 could represent more customers coming back towards Wendy’s higher-priced items as the economy improves.
Remodeling the Brand
Among this extremely competitive industry, Wendy’s is planning on developing an improvement plan, which includes new product introduction, a tiered pricing strategy and an expansive remodeling plan with modern designs and enhanced marketing initiatives. Wendy’s aim seems to be to compete among fast-casual restaurants with a new modern store prototype, looking to offer new-QSR quality at QSR price. Nevertheless, the pricing differential is likely to weaken same-store sales, relative to peers. The company has yet to meet the results of their modernization efforts; re-imaging efforts are indeed most needed among this industry, but the competition is always alert and can easily replicate the offering.
Stuck in the Middle: Bottom Line
Analysts think operating margins will improve over the next few years –expected to reach a low-double-digit range- as a consequence of a reduction in commodity cost and a refinement of the cost structure, following the separation from Arby’s the company had during 2011. Indeed the inflation will still strike these companies, and management will have to balance costs pressures with higher prices. However, Wendy’s doesn’t have the pricing power as to implement this strategy as effectively as fast-casual restaurant chains. On the other hand, the firm also lacks the supply control larger players such as McDonald’s has. Wendy’s is somehow caught in the middle between this two restaurant formats, and should be looking towards an increase in traffic through marketing advertising and product mix adjustment, rather than price raise.
Buy-bound analysts state that the popularity the new products released by Wendy’s had has already re-invigorated the firm, and given the management’s commitment to keep the constant product innovation, there is a good chance the company might sustains growth momentum. This limited-time product development strategy could become the best strategy for QSRs as to lure customers, increase traffic and beat the competition. Also, the transition towards the franchise model will offer Wendy’s a more predictable and stable source of cash flow due to royalty fees. This franchising system, however, will make the firm incur significant capital expenditure in the coming years. Competition is still intense, and the pricing power the firm has isn’t as big as to assure income margins. Relying on premium burgers and single popular products might not compensate the fact that Wendy’s doesn’t have the cost control larger peers have. On top of this, given the macroeconomic pressure, higher gasoline prices, payroll tax increase and relayed tax refund checks, there’s a chance Wendy’s might face some setbacks during 2014.
Disclosure: Damian Illia holds no position in any stocks mentioned.