WEN: FOCUSED, REAL & UNDERVALUED

There are some investor meetings that can be boring and many times you walk away saying to myself “why did I even waste my time; I did not learn anything.”  But this meeting was different and I decided to sit in the front row.  Maybe it was because Nelson Peltz was going to say a few words and I wanted to make sure I got a good look. 

 

History may not repeat, but it certainly does rhyme; I have made this call a least a dozen times in my career and two of them in the last two years (SBUX in 2009 and EAT in 2010).  Senior management is finally getting down to doing what should have been done two years ago – letting the Wendy’s brand thrive on its own.    

 

Wendy’s is following the classical rinse and repeat process of successful restaurant turnaround stories: simplify operations by shedding any surplus, dilutive brands that are distracting management and focus on executing the core business to the highest level possible.  Today’s investor meeting shed plenty of light on the progress WEN is making on this path and, while some question marks remain, I was convinced that the painful lesson of the Arby’s merger has been fully absorbed by management and they are now poised for significant growth over the longer term.   The presentation, in its totality, put forth a frank account of the errors that WEN had made in terms of operations and a convincing list of steps it is now taking to turn around the concept. 

 

The meeting obviously kicked off with Wendy’s new breakfast, supplied by Wendy’s, and the team was quick to tell the audience about the new rollout.  According to management, the day part has the potential to add $150,000 to the concept’s $2.4 million in average unit volumes.  The immediate success of breakfast is not critical, to the degree that management does not build in a significant expectation on what it will add to same-store sales growth.  They will only have it in 1,000 stores by the end of next year and only 2/3 of the system will be able to execute it. 

 

The most critical element to the turnaround is management’s plan to upgrade the menu to enhance the quality of its offerings.  This new menu strategy focuses on introducing new products that compete with some of the more premium products and brands in the QSR segment.  The company has rolled out new “natural cut” French fries that rival the style of those available at Five Guys.  Additionally, the company will be rolling out a new hamburger called the “golden burger” which is expected to compete with the quality offered at In-N-Out Burger, Five Guys and other premium prices products.  The new burger will be rolled out nationally during the second half of 2011.  They will also follow up in the coming months with a new chicken sandwich to compete with Chick-fil-A.

 

While unit growth is not currently a focus it remains another vehicle through which management aims to grow the top line.  WEN announced a new partnership in Argentina with Desarollo y Gestion (D&G), to open 50 franchise stores.  Other opportunities are being pursued in Brazil, China, and Japan, and management is optimistic about the prospects in all three markets.  Interestingly, while WEN expects earnings exposure to international markets to increase, it also plans on opening 1,000 new stores on top of the current ~6,000 unit restaurant base.

 

Aiming for operational excellence was a key theme of the presentation and management outlined how it can have the obvious benefit on margins but also on top line trends.  One fine example is the drive-through window.  WEN detailed the significant uptick in sales seen as operational creases were ironed out and speed-of-service times were reduced.   I’m assuming it is for Wendy’s in the U.S., but management said that 67% of sales are made at the pickup window. 

 

Management is also using a pricing model to best calculate stores where there is room for pricing versus those stores where a price increase would likely result in a drop off in traffic.  Remodels are another strategy that the company is following to support sales; 75 remodels are scheduled for 2011. 

 

The presentation elaborated briefly on the current standing of the share repurchase program, which was, of course, interrupted because of the filing of a 13-D by Trian, WEN’s largest shareholder.  For this reason, it was explained, there were no stock repurchases in the fourth quarter.  The current intention is for repurchases to resume as soon as possible.

 

In terms of outlook, management reiterated the guidance disclosed in yesterday’s preannouncement of 4Q and FY2010 earnings.  For 2011, the company outlook expects same-store sales growth of 1-3% at Wendy’s North America company-operated restaurants and an improvement of 30 to 60 basis points in Wendy’s company-operated margins.  Capex is projected to be $145 million.  Unit development is expected to include 20 company stores in North America, 45 franchise stores, and approximately 50 international franchise stores.  From a cash flow perspective, the company aims to produce annual EBITDA growth of 10-15%, beginning in 2012.  Commodity inflation is projected to be around 2-3% for the company with beef costs impacting on approximately a one-month lag basis.  Chicken is contracted out on an annual basis and will offset some of the inflation beef is causing in the commodity basket presently. 

 

While focusing on simplifying the menu and the process (Burgers, Fries, Cokes), the chain is also focusing on simplifying the marketing strategy.  Using the namesake of the brand and daughter of the founder, Wendy Thomas, in select advertising is just one of the initiatives management is using to heighten WEN’s profile among QSR customers of which, according to the presentation, 60 million visit QSR restaurants 4 or 5 times per week in the U.S. 

 

The most positive and all-important take away from this investor day was the resounding “yes” management gave to me in response to my question about whether or not this definitively meant that Wendy’s, as a concept, would now be given sole attention of management and room to breathe.  The response was important and the benefits obvious.  Management teams across the space are generally better served focusing on a few simple operational tasks and executing on them clinically.  The sale of Arby’s allows WEN to forget about trying to right the wrongs of Arby’s and invest capital and management time into Wendy’s.  Of course, from a dollar perspective, the reduction of corporate G&A to support a single brand is also a positive.  Beyond that, focusing on the core menu will also yield benefits.  Hamburgers, fries, salads, value, and chicken comprise 70% of total sales for WEN.  That is a slice of the pie worth getting right.

 

As with all turnarounds there is always the X-factor.  The X-factor in this case is the implication(s) this has for the employees and the franchise system.  You generally see most people be revitalized by the new initiatives and the stores tend to see a higher level of execution and the turnaround progresses.  This is why when the ball starts rolling it goes further and lasts longer than most expect it to.  This was clearly evident in the most recent quarter that SBUX reported. 

 

We will have more details around valuation in the coming days. 

 

Howard Penney

Managing Director


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