The Wendy’s Company (WEN) recently posted second quarter 2014 results and announced further plans under its ongoing system optimization initiative. It also reaffirmed its outlook for 2014. Share price of the company increased 2.3% post announcement of results.
Wendy’s second-quarter 2014 adjusted earnings of 9 cents per share were in-line with the Zacks Consensus Estimate and were up 12.5% year over year. The year-over-year rise reflects improved margins, a decline in interest expense and lower share count. Also, earnings were in-line with management’s expectation.
Total revenue in the quarter declined 19.5% year over year to $523.4 million. The downside reflects a reduction in the number of company-operated restaurants as a result of the system optimization initiative. This was partly offset by same-restaurant sales (comps) growth as well as increases in rental income and franchise royalties. Also, an image activation program and spring product promotions helped drive sales in the second quarter. The company had also expected a 20% decline in revenue as a result of franchising 418 company-operated restaurants.
The top line, however, beat the Zacks Consensus Estimate of $517.0 million by 1.2%, which we believe was due to comps growth and sales boost initiatives taken by the company.
Behind the Headline Numbers
Comps at company-operated restaurants increased 3.9%, better than the year-ago comps increase of 0.4% and the prior quarter comps growth of 1.3%. Comps at North American franchise-operated restaurants were up 3.1%, far better than the year-ago comps growth of 0.3% and first quarter comps growth of 0.6%. Improved comps reflect success of image activation program being executed by the company.
Company-operated restaurant margin increased 110 basis points (bps) to 17.8% driven by comps growth and the positive impact of the company's system optimization initiative. However, these positives were partially offset by an increase in commodity costs, mainly beef.
Adjusted earnings before interest, taxes, depreciation and amortization (:EBITDA) increased 2.1% to $104.2 million, which was in-line with the company’s expectations.
Third Quarter and Fourth Quarter Guidance
For the third quarter, the company expects significant year-over-year increase in temporary restaurant closures due to speeding up of reimaging activity. Therefore, it expects same restaurant sales growth to be slightly less than the low end of the full-year outlook of 2.5% to 3.5%. Also, it expects adjusted EBITDA to be flat. However, in the fourth quarter, adjusted EBITDA is expected to increase year over year.
2014 Outlook Reiterated
Wendy’s has reiterated its outlook for 2014. The company projects adjusted earnings to be within 34–36 cents per share in 2014, up from 2013 levels. Management expects adjusted EBITDA in the range of $390.0 to $400.0 million, representing an increase of 6% to 9% year over year.
Average same-restaurant sales growth is expected to be in the range of 2.5% to 3.5% at company-operated restaurants. Further, the company expects a reduction in interest expense of approximately $15 million, resulting from the 2013 debt restructuring.
Capital expenditures are expected in the range of $280 to $290 million, including approximately $215 million for company-operated image activation of restaurants.
Wendy’s expects company-operated restaurant margin in a range of 16.3% to 16.8%. The guidance reflects higher beef costs in the second half of the year.
System Optimization Initiative
After completing the sale of 418 company-owned restaurants in Mar 2014, Wendy's now plans to sell 135 i.e. 100% of the company-operated restaurants in Canada to new and existing franchisees. It intends to complete the transaction by the end of first quarter 2015.
In 2014, the company expects ongoing annualized reduction in general and administrative expenses of approximately $8 million after completing these transactions, in addition to $30 million savings owing to the completion of the sale of 418 U.S. restaurants. It also expects higher cash flow due to the expected increase in rent and royalty revenue, as well as lower ongoing capital expenditures.
The company expects the sale of its Canadian restaurants to reduce adjusted EBITDA by approximately $5 million in 2015, resulting in adjusted EBITDA growth in the mid-to-high single-digit range in 2015.
However, it expects the transactions to be neutral to EBITDA in 2016 and accretive to adjusted EBITDA in 2017 and thereafter. It expects adjusted EBITDA growth in high single-digits in 2016 and low-double-digits adjusted EBITDA growth beginning in 2017.
Moreover, it expects the transactions to be neutral to net income in 2015 and slightly accretive to net income beyond 2015. Adjusted earnings per share are expected to grow in mid-teens beginning 2015, which reflects annual same-restaurant sales growth of at least 3%.
Despite sluggish sales, the decent earnings performance signals that the restaurateur is successfully transitioning itself and working on its cost structure. Menu innovation, re-imaging of units, net domestic unit growth and international expansion bode well for the near future. Comps also posted a decent show. However, an increase in commodity costs remains a headwind for the company. Moreover, reduction of company-owned restaurants would pressurize sales in the near-term.
Wendy’s presently has a Zacks Rank #4 (Sell). Better-ranked stocks in the same industry include BJ's Restaurants, Inc. (BJRI), Chipotle Mexican Grill, Inc. (CMG) and Jamba, Inc. (JMBA). All these stocks sport a Zacks Rank #1 (Strong Buy).
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