U.S. Markets close in 1 hr 39 mins

Wendy’s Jumps on Upbeat Profit, Refranchising Plan

The Exchange

Wendy's (WEN) shares were surging Tuesday after the hamburger seller said it would focus even more on franchising, a move that will serve to lower certain costs while boosting its rent and royalty revenue.

Wendy's meal

The news meant its scheduled earnings report, which was positive for the second quarter and upbeat regarding future profits, took a bit of a back seat to word that it's hoping to better manage its expenses and income. To help do so, it will sell approximately 425 company-owned restaurants, after which it will own about 15% of the Wendy's outlets, down from 22% currently. Wendy's is aiming to complete the sales by around the middle of next year.

Recently, its shares were up 11.7% to $7.46 in heavy trading. Less than an hour into the session, volume already had exceeded the average total for a normal full day. Even before the advance, Wendy's stock had gained 42% this year, according to Yahoo! Finance data. Worth noting is that the climb may be getting an added charge from short positions being closed. With 14% of its float sold short at the end of June, Wendy's has attracted greater selling interest than most of its fast-food peers, though Burger King (BKW) is close.

Recent makeover

Dublin, Ohio-based Wendy's has been undergoing a makeover that includes updating its restaurants and its menu to try and differentiate itself in an extremely competitive industry, one which is seeing customers get more discerning. On the marketing side, it recently altered its logo and retooled its ad campaign. In a press release, the company said the sale has started, beginning with 24 units in the Kansas City area going to a division of large restaurant operator NPC International on Monday. The company has also sold five restaurants in the Kansas City market to a long-time franchise owner.

Franchising is popular for chains in that it decreases the corporate expenses associated with owning and operating locations, while creating predictable cash flow via the franchised units. McDonald's (MCD), which is much larger than Wendy's, franchises about 81% of its more than 34,000 restaurants around the world, whereas in 2006 it franchised about 72%. Burger King has a large-scale sale underway, and ultimately it expects to own very few of its restaurants.

Wendy's 1-year chart

At the end of last year, the Wendy's system had 6,560 restaurants, with 1,427 owned by the company. The sales from the restaurants being shed will of course be gone. However, Wendy's says its franchise plan will lower annualized general and administrative expenses, improve margins at company-operated restaurants by allowing it to focus on more-profitable stores, provide higher rent and royalty revenue and reduce depreciation expenses.

Another dividend boost

Meanwhile, Wendy's raised its dividend for the second time in a matter of months, saying its quarterly payout will rise to 5 cents from 4 cents. The company lifted the dividend to 4 cents from 2 cents in the fourth quarter.

As for its earnings, Wendy's had an adjusted profit of 8 cents a share, up from 5 cents in the year-earlier period. After items, Wendy's earned 3 cents, compared with a loss of a penny a year prior. Revenue rose to $650.5 million from $645.9 million in the 2012 second quarter. Analysts surveyed by FactSet were calling for earnings, before items, of 6 cents. While the profit beat estimates, sales were about $6 million short of the consensus forecast. North American company-operated restaurants had a same-store sales increase of 0.4%. At franchised locations, comps were up 0.3%.

For the full year, Wendy's, which earlier in 2013 hiked its outlook, said it was "trending toward the high end" of its adjusted profit estimate of 20 cents to 22 cents a share. The average estimate is 20 cents.

Because of the re-franchising plan, Wendy's believes its long-term adjusted EPS growth rate will be in the mid-teens beginning next year, an improvement from its old expectation of high single-digit to low double-digit growth.

This all may help Wendy's keep its premium multiple. At a forward price-to-earnings ratio well past 30, it trades well above the levels of McDonald's, Burger King and Yum! Brands (YUM).