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Wendy's (WEN) Shares Gain 6% Year to Date: More Room to Run?

Zacks Equity Research

The Wendy's Company WEN is expected to tread on a growth trajectory, given its strong expansion strategies to drive top-line growth. The company is also witnessing top-line momentum, resulting from increased investments in technology and reimaging of restaurants. Menu innovation is also likely to boost traffic and drive sales in the months ahead. However, higher labor and commodity costs, along with capital spending, may dent margins.

Although the company’s shares have lost 4.5% over the past year, we have observed resilience in the stock movement over the past month. In fact, on a year-to-date basis, shares of Wendy’s have gained 5.8%, outpacing the industry’s rally of 3.2%.

Factors Likely to Drive Growth

Wendy’s is benefiting from its transition into a franchised business model. In 2017, the company had several first-time builders and doubled the number of franchises from 2015 by building restaurants. Though the reduction in ownership has been weighing on the company’s revenues over the past few quarters, we believe it will lower its general and administrative expenses, thus, boosting earnings in turn. Subsequently, the Zacks Consensus Estimate for earnings in 2019 is pegged at 66 cents, reflecting 15.3% growth on a year-over-year basis.

Meanwhile, the company plans to continue facilitating franchisee-to-franchisee restaurant transfers through its buy-and-flip strategy. Such a move ensures that restaurants are in the safe hands of well-capitalized franchisees, which are committed to long-term growth.

Another growth driver for Wendy’s has been its relentless focus on expansion. The company is trying to take its global restaurant count to 7,500 by 2020. It has growth plans and partnerships in Argentina, the Philippines and Japan.Significantly, Wendy’s achieved total net new development of 97 restaurants internationally in 2017, mirroring 1.5% year-over-year growth. In the first nine months of 2018, the company opened 109 restaurants as part of its expansion endeavors.

Wendy’s remains on track to achieve at least 70% Image Activation goal for 2020 as part of its brand transformation initiative. This program has gained traction in the recent past, leading to increased traffic and higher sales at its restaurants. At the end of 2017, 43% of the global system featured the brand’s new image. Interestingly, as a result of this re-imaging, customers saw some bold designs and friendlier restaurant teams.

Backed by such top-line initiatives, the consensus estimate predicts revenues to increase 3.8% year over year in 2019.

Increased Costs Hurt

In order to drive growth, Wendy’s is taking initiatives to re-align and re-invest its resources. Though these initiatives are expected to benefit Wendy’s over the long term, the same is likely to increase costs in the near term, denting margins in turn. Furthermore, the company is likely to have faced labor inflation of roughly 3-4% and commodity inflation of around 1-2% in 2018.

Wendy’s is also likely to incur additional capital expenditure in the coming years in a bid to boost the re-imaging program. This might lower its free cash flow in the near term. Though the company has transitioned into a franchise-based model that requires lesser capital expenditure, it is likely to take some time to reap benefits. In fact, it might have had a capex of approximately $75-$80 million in 2018.

Zacks Rank & Stocks to Consider

Wendy’s currently carries a Zacks Rank #3 (Hold). Some better-ranked restaurant stocks are BJ’s Restaurants BJRI, Darden DRI and Cracker Barrel CBRL, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Earnings for BJ’s Restaurants, Darden and Cracker Barrel for the current year are projected to increase by 66.7%, 16.8% and 16.9%, respectively.

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