Wendy's Optimization Initiatives on Track, Costs a Concern - Analyst Blog
On Dec 31, we issued an updated research report on The Wendy's Company (WEN).
On Nov 6, 2014, Wendy's posted third-quarter 2014 results with both earnings and revenues missing the Zacks Consensus Estimate. However, the company reaffirmed its earnings guidance for 2014 and expects it in the range of 34 cents to 36 cents per share in 2014.
Wendy’s third-quarter 2014 adjusted earnings of 8 cents per share remained flat year over year. Total revenue in the quarter declined 20% year over year to $512.5 million. The downside reflects a reduction in the number of company-operated restaurants. Also, an image activation reimaging program led to some temporary restaurant closures, which negatively affected revenues.
As a part of its brand transformation program, the company is working on a system optimization initiative that aims at changing its business to a franchise-based model, which involves selling company-operated restaurants. After completing the sale of 418 company-operated restaurants in 2013-2014, the company plans to sell approximately 135 company-operated Canadian restaurants under the same initiative by the end of first quarter of 2015.
This additional sale would lower its ownership from 15% to 13%. Though the reduction in ownership is currently weighing on its revenues, we believe franchising a large chunk of its system will lower its general and administrative expenses and thereby boost earnings going forward.
Moreover, over the long-term, it would generate a higher return on equity by lowering capital requirements. This would also boost free cash flow, thereby enhancing shareholder return. Besides adding to the top line in the form of royalty and rental income, it would allow the company to penetrate the market more quickly.
Additionally, we remain encouraged by the company’s sales initiatives, which include menu innovation, international expansion and re-imaging of units. The re-imaging program began in 2011 and has gained traction in the past two years leading to increased traffic and adding to sales at its restaurants. Meanwhile, the company’s efforts to explore growth opportunities in key international markets as well as less saturated developing markets offer enormous growth opportunities.
However, like other restaurant chains, rising food costs remain a headwind for the company. The price of beef has been increasing for the past few months. Margins are expected to be negatively impacted by food costs, particularly higher-than-expected beef prices. In fact, the situation is not expected to improve in the near term. In fact, the company lowered its operating margin guidance for 2014 owing to higher beef costs.
Moreover, Wendy’s has been under pressure from worldwide wage increases. Meanwhile, in order to compensate for these costs, the company is taking steps to re-align and re-invest resources. These initiatives might benefit the company over the long-term but are expected to negatively impact margins in the near term. Wendy's Company presently has a Zacks Rank #3 (Hold).
Some better-ranked stocks in the restaurant industry, which look attractive at current levels, include Cracker Barrel Old Country Store, Inc. (CBRL), Bob Evans Farms, Inc. (BOBE) and Chipotle Mexican Grill, Inc. (CMG). All these stocks carry a Zacks Rank #2 (Buy).
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