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A New Look at Wendy's

We are maintaining our "buy" rating on Wendy’s Co. (WEN); we believe that Wendy’s has revitalized its brand over the last three years by selling more than 800 company-owned restaurants, suggests John Staszak, analyst with Argus Research.

By the end of 2017, WEN had sold nearly all company-owned restaurants that it had planned to sell, and just over 30 locations are now company-owned. Meanwhile, in 2018, Wendy’s built 44 new restaurants in North America, and opened nine international locations.

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The company’s recent refranchising efforts will increase rent and royalties (4% of franchisee revenue), and provide a more reliable sales and earnings stream. Although operating earnings typically decline following a refranchising, Wendy’s expects EBITDA to be unaffected, driven by $30 million in annual G&A savings.

As part of the refranchising, Wendy’s expects franchisees to remodel their restaurants. Remodeling will cost $400,000-$750,000 per restaurant, and is an important part of the company’s efforts to boost its brand image.

The company and its franchisees have already remodeled 48% of restaurants, and the remodeled restaurants are generating significantly greater revenue on average than older locations. The company is also working to strengthen its brand through new product launches and stepped-up marketing.

Consistent with management’s guidance and recent positive earnings surprises, we are maintaining our EPS estimates of $0.67 for 2019 and $0.80 for 2020. Our long-term EPS growth rate forecast is 14%.

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We believe that WEN’s projected 2020 EV/EBITDA multiple of 13.8 inadequately reflects the higher margins and more stable revenue streams that occur when nearly all restaurants are owned by franchisees. We believe that the stock merits a higher multiple of 16.4 and that a "buy" rating remains appropriate.

Our revised $26 target price implies a multiple of 32.5-times our 2020 EPS estimate, above the average for small to midcap fast food chains, but warranted, in our view, by Wendy’s efforts to reduce G&A expense, eliminate debt, improve profitability, buy back stock, and raise the dividend.

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