Founded in 1969, Dublin, Ohio-based The Wendy’s Co. (WEN, Financial) operates a quick-service restaurant chain that is known for its hamburgers. The company operates under three business segments: Wendy's U.S., Wendy's International and Global Real Estate & Development. At the end of 2021, Wendy’s owned 403 company-operated restaurants, 5,535 franchised restaurants in the U.S. and another 1,006 restaurants internationally in 29 countries.
Wendy’s has come under pressure this year, along with many other restaurant stocks, presenting an opportunity for value-oriented investors to consider adding it to their portfolios. As discussed below, the company has taken several strategic steps to drive future growth and these initiatives could help Wendy’s unlock new growth opportunities in the coming years.
Long-term-oriented strategies
Wendy’s is investing in its brand transformation strategies, such as menu innovation, new packaging and promotional offers. The company now includes customized sandwiches and hamburgers, with unfrozen beef on its menu and innovative products such as the Classic Chicken Sandwich, Pretzel Pub Cheeseburger, Bourbon Bacon Cheeseburger and Summer Strawberry Salad contributing to the earnings beat in the fourth quarter of 2021. By the end of this year, Wendy’s is expecting to get rid of gestation stalls from its pork supply chain, which will be an excellent move toward preparing health-conscious meals.
The restaurant chain, which launched its breakfast menu nationwide in March 2020, acknowledged during its fourth-quarter earnings call that it has achieved the third-largest market share of 8.5% in the breakfast business in the U.S. Only Burger King and McDonald's Corp. (MCD, Financial) have a higher market share, which highlights the strong momentum the company has gained in just a couple of years. The progress made by Wendy’s on this front is a testament to the strong brand value associated with its products, which is an important characteristic to remain profitable in a highly competitive industry. Digital Journal expects the global breakfast restaurant market to grow at a compound annual rate of 6.8% through 2028, so the company's decision to focus on its breakfast menu seems like a good decision that could help it sustainably grow in the next five years. Last year, Wendy's was able to grow its breakfast business without cannibalizing lunch and dinner traffic, which is a very good sign as it seems to be on track to drive same-store sales to higher levels.
Wendy’s is also continuing to invest in digital initiatives, such as mobile payments, online ordering and customer self-order kiosks, to offer a faster and more convenient service to its customers. The number of loyalty program memberships grew 75% last year and the company’s digital sales continued to grow as well, suggesting that its digital investments are yielding lucrative returns.
To ensure orders are delivered to its customers seamlessly, the company is now collaborating with Grubhub, Postmates and Uber Eats. Partnering with major delivery partners in the U.S. will help the company penetrate untapped markets.
On April 2, Wendy’s officially entered the metaverse as well, which makes it one of the few restaurant companies to embrace this new technology. In partnership with Meta Platforms Inc. (FB, Financial), Wendy’s launched Wendyverse to lure customers to its very own virtual world to place orders using a Quest 2 VR headset. The augmented reality platform still has a long way to go, but for now, this tool is designed to increase customers' desire to interact with Wendy’s. The company plans to invest in improving the technological capabilities of Wendyverse to offer a second-to-none experience to its customers in the future, which will be key to maintaining steady growth.
The company is aslo investing in expanding its footprint overseas with the understanding that global markets will offer the opportunity for it to grow faster in the next five years given that the American market is mature. In pandemic-stricken 2020, Wendy's opened 150 new stores globally when many restaurant chains were focused on scaling down to cut losses, which gives a clear indication of the long-term-oriented nature of business decisions taken by the management team. Even in 2021, when supply chain issues were making life difficult for restaurant companies in every part of the world, Wendy’s opened more than 200 restaurants, including two restaurants in the U.K.
The company is quite ambitious in its expansion plans with a target of 8,500 to 9,000 stores by 2025. Although new store openings could exert pressure on its short-term financial performance because of an increase in capital expenditure, Wendy's is moving in the right direction by using a franchise model to keep costs to a minimum while enjoying the benefits of expanding internationally.
As these business decisions were made with long-term growth in mind, Wendy's seems to be headed in the right direction to create shareholder wealth in the future.
Keep an eye on operating margins
The reported revenue of Wendy’s for the fourth quarter of 2021 showed a decline of 0.2% year over-year, but excluding the impact of an additional week in the fourth quarter of 2020 compared to 2021, revenue grew 0.8%, aided by the opening of 58 net new units, the uptick in franchise fees and improved franchise royalty revenues. Although this performance is encouraging, investors should keep an eye on one major risk that could cap the company’s growth this year: the possibility of a contraction in operating margins resulting from inflationary pressures.
Being in the retail restaurant space, rising labor costs and commodity prices will have an impact on the financial performance of Wendy’s. The company-operated restaurant margin came to 14.5% in the fourth quarter of 2021 compared to 17.6% in the year-ago quarter, which gives an early indication of how rising costs could become an obstacle to growth. General administration costs rose 8.4% year over year, driven by high incentive compensation and stock compensation accruals. This led to a decline in the quarterly operating profit margin, but due to lower tax rates and interest expenses, the net income was not affected by these negative developments in the most recent quarter.
Going forward, however, it would be reasonable to expect rising costs to be reflected in the company’s numbers. This realization could worsen the selloff of Wendy’s stock before things get better.
The valuation is justifiable
Wendy's is a cash flow-positive company that earns positive free cash flow consistently. This has enabled the company to return excess cash to its shareholders and its dividend now yields over 2.3% at the current stock price of around $21.80.
At a forward price-earnings ratio of 23.41, Wendy's is not cheaply valued in the market, but paying a small premium to invest in the company makes sense given that it is successfully turning around its prospects by focusing on sustainable growth.
Takeaway
Wendy's still has a long way to go to compete with the likes of McDonald's, but it is slowly but surely carving out a brand name by focusing on menu innovation and investments in technology. In the recovery phase of the economy, Wendy's is likely to gain more traction as the company has already laid the foundation to reignite growth as consumers return to physical stores.
