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Wendy’s: A Stock Worth Watching

April 28, 2014 | About:

The Wendy's Company (WEN) is one of the largest quick-service restaurant companies in the United States, with more than 6,500 locations in 27 countries. Recently it has overthrown Burger King (BKW) as second-largest quick-services hamburger chain, behind McDonald’s (MCD). Featuring hamburgers, chicken breast sandwiches and wraps, chicken nuggets, chili, baked and French fried potatoes, freshly prepared salads, soft drinks and Frosty desserts, Wendy’s has been trying to improve traffic by revitalizing its brand through new products, menu shifts, remodels and a reinvigorated marketing campaign.

Wendy’s is known for providing better quality products at a higher price. This strategy has hurt the company’s margins amid macroeconomic instability. Nevertheless, the company has recently presented promising results, with fourth-quarter earnings of $0.11 per share, increasing 22.0% year over year, driven by a decline in total costs and expenses.

Improving

Wendy’s tries to compete not only with quick-service restaurants, but also with new QSR such as Panera Bread Company (PNRA), Chipotle Mexican Grill Inc. (CMG) and Five Guys. Store remodeling and new menu items are directed towards competing for new QSR customers, as management believes that it can offer new-QSR quality at QSR price. These efforts have resulted in higher comps at U.S. units, up 3.1% last fourth quarter, driven by the successful promotions of the Pretzel Pub Chicken sandwich and Bacon Portabella Melt on Brioche, also lifted by sales leverage and cost saving initiatives. Moreover, it also plans to renovate some of its existing units based on the Image Activation format, and has already completed re-imaging 200 company-operated and franchise-operated restaurants in 2013. This re-imaging effort is expected to drive top-line growth and expand restaurant margins through 2017.

The transition on track to a franchised based business model is allowing Wendy’s to lower its expenses and stabilize its revenue stream. As a part of this new System Optimization initiative, the company has sold 418 company-operated restaurants concentrated in the U.S. Therefore, with stronger free cash flow, the company will be able to increase its investment in brand recognition and shareholders’ return enhancement. Moreover, franchise systems typically secure companies from macroeconomic fluctuations, perceiving a steady revenue stream despite economic turmoil. Furthermore, Wendy’s is planning to expand its international presence to emerging markets in the Middle East, North Africa, Singapore, Turkey, Russia and the Eastern Caribbean region, among others. Less saturated developing markets offer great growth opportunities and going forward the company aims to continue expansion in international markets.

A Mobile Payment System has been rolling out as well, allowing customers to submit their payments by tapping into an attachment on their phones. This is part of Wendy’s re-imaging program to modernize its business, and it likely to attract more young customers.

Moreover, the introduction of two new items to the menu is expected to increase brand exposure, and is in line with the intended competition with fast-casual restaurants: the Asian Cashew Chicken Salad and BBQ Ranch Chicken Salad. Through these chef-inspired flavors with cutting-edge ingredients, Wendy's aims to provide salad consumers with fresh new tastes they would typically find in casual dining restaurants, but with the speed and price of a quick service restaurant.

Competition and Risks

It is no news the quick-service restaurant industry is exposed to immense commodity and labor cost volatility, which weighs on margins when price increases cannot match cost inflation. Moreover, the competition is intense and the low entering barriers strong threat to these companies. Trying to attract customer with new seasonal items and short-term offers is always a good way to boost sales. However, the removal of these items, such as the Pretzel Burger could hurt sales in the short-term.

Bottom Line

Wendy´s results for last fourth quarter were above analysts’ estimations, with earnings of $0.11 per share, increasing 22.0% year over year due to a decline in total costs and expenses. The transition to a franchised operations mode is likely to help generate free cash flow and boost earnings by lowering capital requirements. Moreover, international expansion, extensive refurbishment of units, and focus on franchising should keep the company well positioned. Despite macroeconomic uncertainty, the company expects sales, franchise revenue and cost of sales to improve during 2014, mainly driven by its menu enhancement, product innovation and strong marketing campaigns. The management expects adjusted EBITDA in the range of $390.0 million to $400.0 million, representing an increase of 6.0% to 9.0% year over year. Wendy’s has a stable cash profile and solid return to shareholders, and has a regular share buyback activity and dividend distribution program. Analysts think the continued share repurchase activity reflects the company's confidence in its fundamentals.

Nevertheless, Wendy’s bottom line has been a drag for quite some time and as the re-imaging strategy is expected to imply significant capital expenditure in the coming years, margins are likely to be hurt. Competition is intense in the quick-service restaurant industry, and therefore poses a challenge to the company’s performance. Still, analysts are feeling bullish on this stock given its recent performance and the success of its transition to a franchised system.

Disclosure: Damian Illia holds no position in any of the stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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