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Conclusion: 3Q10 was a terrible quarter for WEN and I don’t think it will get a whole lot better through the fourth quarter, despite Arby’s October performance, with the food cost outlook unfavorable and management guiding to the low end of their reaffirmed EBITDA growth guidance range for 2010.

Topline trends in the third quarter were disappointing for WEN, to say the least.  For the Wendy’s concept, company same-store sales came in at -3.1% versus -0.2% consensus.  This implies a two-year average same-store sales decline of -2.3% versus the -2.1% two-year average trend in 2Q.  As far as remedies for their soft trends at Wendy’s, management was not forthcoming with much detail. 

The strategy at Wendy’s is clearly in dire need of improvement but today's earnings call did not offer much reassurance that a solution is forthcoming.  QSR management teams across the board are highlighting the value proposition as being a major driver of traffic and it is clear that Wendy’s is falling short in that regard.  The “biggest” negative of Wendy’s sales performance during the quarter was, according to management, the area of value transactions.  There are many questions to be answered as to how the company is being run and what – specifically – can be done to improve the outlook.  The January Investor Day, we were told, will add much clarity to their strategy. However, assuming that the projected rollout of their breakfast program remains scheduled for late 2011, it seems that Wendy’s stands little chance of gaining significant market share any time soon.  In addition, taking market share in the breakfast day part may also prove difficult, but I will withhold judgment until further details are disclosed. 

Arby’s trends in the third quarter were equally disappointing, printing a decline in company same-store sales of 9.5% versus -6.5% consensus.  This result implied a sequential slowdown in two-year trends to -8% in 3Q from -7.3% in the second quarter.  On the plus side, Arby’s’ performance in October was much improved from the third quarter at +5.5% growth in same-store sales.  This was largely due to an increase in transaction counts (double-digit growth) and the impact of national advertising (albeit against October 2009 which also had national advertising). 

Management stressed that October’s success was “not just about advertising” but it was about “many things that we have had in our turnaround plan”.  Management expects sales to soften for the remainder of 4Q at Arby’s as the chain moves from the national advertising it enjoyed in October, to local advertising in November and December.

Costs are certainly not working in WEN’s favor either; cost of sales as a percentage of sales increased by 222 bps on a year-over-year basis and I expect a similar increase in the fourth quarter given another difficult comparison from 4Q09 and the outlook for beef.  As management highlighted, beef costs are not showing much sign of abating any time soon, “I actually think we may have one more quarter where it’s actually a little worse from where I sit today.  And then hopefully, I don’t think we are going to see any significant declines in the first half of the year, but hopefully it will stabilize in 2011”.  This fairly clear-cut outlook, combined with the company’s focus on premium products (fresh, never-frozen beef at Wendy’s and whole muscle Angus roast beef at Arby’s), indicates that the impact of commodity costs will likely be negative for the next three quarters, if not longer.

The outlook for Wendy’s/Arby’s is uncertain.  Management was reluctant to provide much granularity in there forward looking statements, pointing instead to the Analyst Day as the date when all will be revealed.  I am not expecting any silver bullet to be revealed at this event.  From an outsider’s point of view, all signs point to the Captain and being in distress.  Operational difficulties are being compounded by what seems to be a lack of communication between Trian and management.  A very interesting comment from today’s earnings call went as follows:

“As many of you know, Trian, our largest shareholder has a schedule 13D on file with the SEC, which indicated that it received an inquiry from a third-party expressing interest in a potential acquisition involving the company. And that Trian was considering this inquiry as well as alternatives with respect to its investment in this company. Because of this disclosure, we refrained from buying stock during the quarter.

 

We have asked Trian to bring us to ahead as promptly as practicable, so that we as a company can continue to focus on ways to enhance shareholder value including through commencing share repurchases under our stock repurchase program as legal and market conditions permit.”

 

There is a clear tone of frustration embedded in the quote above and it does not bode well for the company.  I wrote a post entitled “WEN – UNDERVALUED YES, WHERE IS THE OPPORTUNITY?” in June that discussed WEN’s stock and provided a sum-of-the-parts analysis that suggested that the company’s stock was trading below its intrinsic value. 

However, as the CEO of Hedgeye Risk Management, Keith McCullough, is so fond of saying, “A bargain that remains a bargain -- is no bargain”.  A last comment (or lack thereof) that I would like to highlight is management’s reluctance to give any indication as to the FY11 outlook, even with respect to a directional improvement from the -5% in EBITDA growth the company is now projecting for 2010.  The general lack of guidance and confidence in management’s tone is certainly a worry and it is reflected in the data.  A look at the chart below tells you all you need to know.  WEN is in a deep hole, and I don’t see them coming out next quarter.

WEN: MAYDAY! MAYDAY! - wen sigma

Howard Penney

Managing Director