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What’s Working at Wendy’s? A Lot

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Wendy's (WEN) is working furiously to separate itself from the triad it's long made up with Burger King (BKW) and McDonald's (MCD), namely by trying to escape traditional fast food for the promised land – or at least nearby it – of "fast-casual" dining.

The market certainly appears to believe what's taking place at the Dublin, Ohio, Frosty and fries seller makes it a brighter prospect than its brethren. This year, shares of the third-biggest burger chain have surged 85% to $8.69, easily exceeding the 29% gain at Burger King and the 9% increase for McDonald's. The stock has also markedly outpaced the 23% advance in the S&P 500.

Earnings guidance keeps rising, and two dividend hikes have played no small part in this. But it's not just about that. Since Dave Thomas, the founder and face of the company, died in 2002, Wendy's has been on an uneven journey, including the brief merger, now undone, with roast beef sandwich shop Arby's. At the same time, the company has struggled to provide imaginative menu items.

But with a consistent message from the corporate office, upbeat marketing, new-look stores and a major refranchising effort, it appears all this may be changing.

Hammering the idea

To begin, Wendy's is pushing hard on the idea that it's got better food than its competitors. Clearly, it would rather be viewed as closer to the fast-casual side of the quick-service restaurant business than the place occupied by the likes of Hardee's and Jack in the Box (JACK). Fast-casual chains have seen their influence grow amid a mantra of fresh ingredients and extensive customization options, with names such as Chipotle (CMG) leading the way.

Although it might not get there explicitly, Wendy's is leaning in that direction, what it's described as "new QSR quality at QSR price," and is reflected in its insistence on being a "cut above." Wendy's, where 65% of sales at company-owned stores occur at the drive-through window, now wants you to come in and lounge by the fireplace while enjoying cuisine such as the limited-time Pretzel Bacon Cheeseburger.

That sandwich has been on sale since July. Presumably, it's still selling at least fairly well considering it remains on the menu, and it was followed with a chicken version. The company hasn't put out specific data on its sales, but it claims "millions" of Americans have tried it. Janney Capital Markets analyst Mark Kalinowski previously said he expected a substantial same-store sales boost from the burger.

Even if it isn't health food, diners do give Wendy's high marks compared with its chief rivals. The market is buying into this, too.

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Hamburger data

Source: Company websites, annual reports. Prices are sampled from Dallas, TX, stores during the week of Oct. 28, 2013. Store counts are as of Dec. 31, 2012.

Store sales

Certain Wendy's financial metrics are nearer to higher-end, fast-casual operators than to other fast-food venues. Its forward multiple is only one of them, but at a 32, Wendy's trades at a richer level than its direct competitors. That said, it historically has, though it's running 28% above the 25 average of the past five years.

Amid the run-up, short interest has nearly tripled in the past 12 months, so that in mid-October, almost 13% of the float was sold short.

The shorts might be right that Wendy's has gotten over-extended and should pull back, but the company's cost structure and by extension earnings are getting a big assist from the in-process sale of 425 corporate shops. That will lower Wendy's owned-store count to 15% of the system from 22%, and along with shifting more expenses onto franchisees, the company will get a clearer revenue stream from royalties and fees.

Next week, it's expected to report third-quarter revenue of $639 million, with a net of 6 cents a share. Overall this year, Wendy's is projected to turn a profit of about $73 million, what would be its strongest bottom line in recent memory.

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Wendy's financial measures

Source: FactSet. Price changes as of Oct. 31, 2013.

Remodels and marketing

Many Wendy's stores are getting wholesale makeovers, and that's key to the plan to enhance perceptions. McDonald's and Burger King have their own significant remodeling campaigns ongoing, but Wendy's may be seeing the biggest shift from the old style.

Additionally, an ad campaign with Morgan Smith Goodwin, the "Wendy's girl," is solidifying the Wendy's identity, which hasn't always been clear since Thomas died -- and, before that, Clara Peller's "Where's the beef?" was a ubiquitous phrase. Meanwhile, McDonald's has all but hidden away Ronald, and Burger King has dethroned the plastic-headed King. Advantage, Wendy's.

CEO Emil Brolick, at the company since September 2011, told USA Today after his appointment that year that the "brand vision has not been there." His plan, he said, was to "reinvent our restaurant base to maintain relevance."

It could be worse

Another positive is an absence of hate. Wendy's doesn't evoke anything approaching the visceral reaction McDonald's does — you won't find movies about how Wendy's ruins your health or organized campaigns painting it as the scourge of the planet.

McDonald's stirs up so many negative feelings that the company has become almost apologetic about its existence. It recently joined with the Clinton Global Initiative on a health-food effort, and its insistence on discussing egg whites would make a visitor to Earth from outer space entirely unaware it sells millions of Big Macs and Quarter Pounders.

Now it must be noted that, despite the rage McDonald's can cause, its system had sales of more than $88 billion worldwide last year.

Risk areas

Of course, Wendy's day in the sun may end tomorrow. The risks here aren't insignificant. Among them: general economic weakness, stout competition, fickle consumers and the constant fear that one negative piece of food-related news could undo its reinvention.

Pricing power is another. Fast food as an industry has had trouble implementing price increases owing to the sluggish economy, although the big players are trying to change that. Wendy's Right Price Right Size value menu, generally with items at 99 cents to $1.99, is its nod to the diner looking for a lower-priced meal, while at the same time not letting check totals get too low. That's important. Wendy's doesn't have the size or might to weather an extended financial malaise to the extent Burger King or McDonald's can. (In comparison, Burger King's been running a two sandwiches for $5 promo, while McDonald's has bulked up its Dollar Menu to include more expensive items.)

And let's not forget Wendy's Chairman, and activist investor, Nelson Peltz. On his own and through his firm Trian, he's overseeing about one-quarter of the common stock. In other words, nothing happens without his approval. Depending on your perspective, that could be very good — or very bad.

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