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WEN – CLASSIC TURNAROUND STORY

Wendy’s is following the template for restaurant company turnaround success.

 

Following the Wendy’s Investor Day on January 27th, my view on this stock changed and I became more convinced of the long term prospects of the company’s stock.  The primary reason for that was the assurance management gave me during the Q&A session that Arby’s would be sold and the company would remain focused on one brand, Wendy’s.  Another crucial reason was the company’s renewed focus on revitalizing, not complicating, the menu in 2011.  The company’s focus on selling burgers and cokes will, in my view, yield significant results in terms of sales, labor efficiency, and – ultimately – earnings.

 

WEN 4Q10 earnings came in at $0.01 ex-items, in line with expectations and guidance.  Comparable restaurant sales at Wendy’s were slightly disappointing given that comparisons were easy due to the terrible performance in 4Q09.  Going forward, comparisons become more difficult, particularly in 1Q11.  While weather is not a factor to which we allot too much importance, management commented that company-operated same-store sales in January were negative but estimates that weather negatively impacted North America comps by between 1.5% and 2%.  Additionally, management did reveal that comps were positive at Wendy’s in February and guided to “flat-to-positive same-store sales for the first quarter.” 

 

Specifically, the company highlighted that if it can just maintain trends seen in February in the March timeframe, then this 1Q11 comp guidance is achievable.  For the year, management guided to comparable restaurant sales of 1-3% at Wendy’s, complemented by an improvement of 30 to 60 basis points in company-operated restaurant margin. 

 

In terms of EBITDA guidance, the company anticipates pro-forma EBITDA between $345 million and $355 million, inclusive of a G&A reduction that occurred as of the beginning of fiscal 2011 (related to the assumed sale of Arby’s).  The EBITDA guidance is also inclusive of the sales guidance described above.   In terms of stock repurchasing, the company stated that it intends on buying back shares pending market conditions and the current authorization stands at $250 million.  

 

Management struck a careful but confident tone on the earnings call when discussing its outlook for 2011, describing it as a “transitional year”.  Management, as previously announced, is exploring a potential sale of Arby’s and describes the benefits of this sale as being accretive to both Net Income and Free Cash Flow.   Of the company’s current $1.1 billion in net debt, roughly $200 million is attributable to Arby’s.  The company’s healthy cash balance, of $512.5 million, will be used to fund ongoing initiatives including the remodeling program and technology enhancements.  The national rollout of Wendy’s new burger in 2H11 will require incremental capital spending of approximately $13,000 to $23,000 per store.  Without the burden that Arby’s represented for the company, there is more dry powder to be spent on the Wendy’s brand and management has a clear, formulaic plan for Wendy’s going forward.

 

The seven initiatives the company is outlining for the Wendy’s brand for 2011 are as follows:

  1. Continuing to enforce “Real” brand positioning as new products are rolled out
  2. Launching new cheeseburgers this fall after positive testing
  3. Continuing to promote “my 99” value menu
  4. Expanding breakfast into new markets
  5. Focusing on operational excellence to improve the customer experience
  6. Continuing the remodeling program
  7. Preparing for new restaurant growth in North America and Internationally

The company’s focus on improving their core products is anathema to the issues I see in MCD’s current business in North America.  While MCD’s overly-complicated menu is overwhelming for staff and customers alike, WEN is focusing on improving their core offerings with select, non-disruptive, new menu items being rolled out this year.  Among the new items being rolled out include a “fish and chips” offering coming in March and a new seasonal salad in the second quarter.   

 

In terms of remodels, the company is also intent on pursuing an aggressive path and will reveal its new restaurant design on a future call.  Unit expansion is the final major focus for WEN.  Management envisions 1,000 stores in North America and plans to add more than 60 new restaurants to its system in 2011 and to increase the pace of development in 2012.  In terms of international expansion, development agreements have been signed in Singapore, the Middle East, Russia, the Caribbean and Argentina over the past couple of years.   Over the long term, management sees 8,000 stores as being possible in international markets with China, Russia and Japan representing 40% of that number.

 

WEN – CLASSIC TURNAROUND STORY - wen sss

 

Commodity exposure is, of course, a key headwind for the company and management provided frank commentary around this issue both in terms of Wendy’s and the broader industry.   Regarding beef costs at Wendy’s, management stated that “Wendy’s food costs will reach a higher level in Q2 and Q3 because of the timing of when we will recognize those increases.  Arby’s will also be facing very high beef prices…15% or more increase year-over-year.”

 

There was some skepticism on the earnings call this morning that margins would actually grow at Wendy’s but management confidently responded to questions on this subject, pointing out that a combination of same-stores sales increases, driven by mix and traffic gains, will help make the margin growth possible.   Despite this, Steven Hare did concede that, “like everyone else, we are nervous about the pressures we are seeing on commodity costs”.

 

The growing sales mix of Wendy’s value menu since the launch of its My 99 everyday value menu will put increased pressure on the company’s margins, but during this turnaround, investors will likely be more focused on the concept’s ability to gain market share.  To that end, management noted that this new value menu has helped to drive transaction trends and enabled Wendy’s to outperform its competitors in November, when it launched My 99, on a share of value traffic basis.  Nevertheless, in terms of factors within management’s control, it is clear that the Wendy’s brand is gaining traction and management has the plan and the capital to execute through 2011 and into 2012.

 

 

Howard Penney

Managing Director



Cupid Shoots 73%

With sales day becoming less relevant due to fewer companies reporting, there are still a handful callouts from today’s reports.  Overall, 16 of 22 (73%) companies reported better than expected results while just six fell shy of Street expectations.  Valentine’s Day was a success, which certainly puts some pause in questioning the propensity of the consumer to shop for purely discretionary goods.  Februrary marks the second month a row of accelerating results on one, two, and three year basis.  Despite the noteworthy strength, it’s important to realize that the bulk of the first quarter’s volume is still very back half weighted due to this year’s three week Easter shift.  As a reminder, most retailers will be reporting negative comps in March followed by sharply positive results in April (based solely on the calendar). 

 

As always, here the notable callouts from February sales results:

  • ROST noted that pack-a-way now stands at 47%, up a full 14% year over year.  Given the fact that costs are on the rise, especially for fall ’11, we suspect the increased pack-a-way will provide nice margin cushion this fall.
  • Almost every retailer noted that momentum throughout month improved each week, with the final week showing the greatest year over year growth.
  • Apparel was the clear standout for the month, with early positive momentum in spring sell-throughs.  Hardlines, especially electronics and media, remained relatively weak for the month.
  • Kohl’s noted strength across all categories during the month, with men’s, women’s, kid’s, footwear, and home all posting positive comps. 
  • For those focused on comparisons, JWN reported its 18th month in a row of increased transaction counts.  Average ticket also increased for the month.
  • Just days after JCP provided guidance for e-commerce sales to increase by low double digits for the year, the company reported its strongest monthly increase of 11.8% in a long time.  Clearly the near term data has given management confidence given the .com has not sustained double digit increase at any point over the past few years.
  • TGT fell short of Street expectations for the third month in a row with the reporting of 1.8% comp increase.  While the result is “in line” with management’s expectation, it still appears light relative to the incremental 200-400bps of comp expected from the company’s P-Fresh and 5% rewards program.
  • TGT will have one of the more pronounced Easter shifts, with same store sales planned down mid to high single digits in March followed by a mid-teens increase in April.  Overall results for the quarter are expected to increase low single digits as per management’s current view.
  • Gap downplayed its disappointing negative 3% comp by saying, “February is a relatively small month and we remain focused on our full-year goals”. 
  • The northeast and mid-atlantic were often cited as the best performing regions for most retailers.  Upon further digging, it should be noted that these regions were impacted by major snowfall last year, making comparisons very easy.
  • LTD noted a strong response to the company’s Valentine’s Day gifting assortment, which helped to drive a 15% increase in comp store sales. 
  • Macy’s reported a 30.9% increase in online sales, which marks an acceleration from prior months.

 Cupid Shoots 73% - SSS1

 

 

Eric Levine

Director


Trichet Boosts Rate Hike Expectations, Markets Cheer

Positions: Long Germany (EWG); Short Italy (EWI), short Eastern Europe (ESR)

 

Below we recap the important policy decisions and data points out of Europe this week:

 

In a Q&A session after the ECB announced no change to its key interest rates this morning, ECB President Jean-ClaudeTrichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.

 

And both the EUR and European equity markets cheered on the news. The EUR-USD rose to an intraday high of $1.3966 and European equity indices gained to close up +50 to 150bps today.

 

Trichet also made it clear that today’s decision was based on data taken from mid-February, and therefore did not include the recent move in crude prices, which created further speculation that greater inflationary readings next month may boost the probability of an interest rate hike. 

 

Our position remains that both the ECB and BOE will act to address their respective inflation pressures well before Ben Bernanke does, as The Bernank chooses to ignore the looming pressures of domestic and global inflation. On this basis we’d also expect the broader US market to underperform many of its European peers.

 

In comments today, Trichet said the range for Eurozone inflation (CPI) has shifted upwards to between 2.0% and 2.6% in 2011 and between 1.0% and 2.4% in 2012, mainly due to “the considerable rise in energy and food prices.”

 

This week we received new monthly Eurozone CPI and PPI numbers that confirm the rising tide of inflation. CPI rose 2.4% in February year-over-year versus 2.4% in January; and PPI increased 6.1% in January Y/Y versus 5.3% in December. The PPI report showed that energy prices jumped 13% from a year earlier.

 

Trichet Boosts Rate Hike Expectations, Markets Cheer - t1

 

 

European PMI Slowing?

 

European February Manufacturing and Services PMI reported this week show mixed signals. As we chart below, we believe the 60 level is a heavy resistance line for PMI numbers going back historically. If we look at the Manufacturing data, we largely see an improving trend for Europe’s largest economies, but caution that both Germany and the UK should slow on the margin in the coming months as they’re already well through the 60 line.

 

Trichet Boosts Rate Hike Expectations, Markets Cheer - t2

 

Services PMI show that Germany failed at the 60 line this month, as France improved just short of 60.  Importantly there’s a clear spread in the Services readings between the UK and Germany. We continue to see fundamental drags in the UK economy due to its austerity programs and rising inflation, both of which are choking off real growth. 

 

Trichet Boosts Rate Hike Expectations, Markets Cheer - t3

 

 

Germany’s Bullish Strut

 

German retail sales were released today and showed an improvement of +2.6% in January year-over-year versus -0.5% in December, or +1.4% in January month-over-month. Also, the German unemployment rate, reported earlier in the week, fell 10bps month-on-month to 7.3% in February. We remain bullish on Germany and are currently long the country via the etf EWG in the Hedgeye Virtual Portfolio. The DAX remains broken on a TRADE basis (3 weeks or less), however it is trading comfortably above its TREND (3 months or more) line at 7,016.

 

Trichet Boosts Rate Hike Expectations, Markets Cheer - t4

 

 

For another week we see attention shift away from Europe’s sovereign debt contagion to uprising in MENA and therein the implications for crude prices. On a bullish note, in an auction today Spain saw solid demand for €1.15 Billion of bonds due 2014 and 2016, with yields coming in considerably lower versus a previous auction of similar maturity. However, risk still loom large in Portugal, with sentiment rising this week that the country will require a bailout in the next weeks. We continue to monitor government yields as a proxy for this risk (see chart below).  Stay tuned.

 

Matthew Hedrick

Analyst

 

Trichet Boosts Rate Hike Expectations, Markets Cheer - t5


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Price Volatility: SP500 Levels, Refreshed

POSITION: no position in the SPY

 

Not surprisingly, with the Hedge Fund Industry running with its highest net leverage since October of 2007 (all time high for SP500), price volatility is back.

 

As Fed fans will recall, the game in late 2007 was a gigantic game of chicken as to when the Fed was going to cut rates. Today, the causal factor remains the same (the Fed daring people to chase yield), but we’re gaming the probability of QG’s instead of rate cuts. After you cut to zero, that’s all you have left.

 

I haven’t made any sales yet today because I think the probability just went straight up of a test of the prior closing YTD high (1343). The better than expected fundamental (jobless claims of 368,000) supports that probability. Whether or not it sustains itself and trumps $101 oil is the game that we’ll be playing next week.

 

In the chart below you can see my immediate term TRADE line of resistance (1341) sits just inside of my intermediate and long-term TREND and TAIL lines of resistance (1343 and 1346).

 

So, if you didn’t know why we have price volatility back in the game, now you know. The Street is finally levered long bullish.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Price Volatility: SP500 Levels, Refreshed - 1


PSS: When Boring is Exciting

 

PSS hit one right down the middle.  The annuity-like characteristics of Payless funded above average growth in the sexier part of the portfolio. This might be the quarter that people realize that PLG exists.

 

It’s been a while since we could refer to a PSS quarter as being ‘boring.’ That’s a good thing for such a high beta stock. Our thesis on this name is quite simple – use cash flow from a fully mature US store base to fuel growth in its stable of premium brands and International Payless retail business. When investors focus heavily on the prospect for a meaningfully positive US comp, we get worried. Same thing for a big negative comp. Why?  Because both are unsustainable.  

 

This quarter’s flattish comp (+0.4%) was about in-line. Importantly, it’s on an improving trend on the margin – at the same time PSS’ compares get easier in the coming two quarters. We’re still banking on marginally positive comp for the next two quarters, but we have more confidence that they’ll get there.

 

Additionally, in a move that is likely to get overlooked, management stepped up its cadence on domestic net store closures from 9 in 2010 to 40 in 2011. While this only represents 0.9% of Payless stores, we think it should help comp challenges, working capital, and profitability (and not to mention managements’ time and focus) on the margin. 

 

Looking at PLG, it was kind of a mixed bag. Top line slightly missed our estimate – but still came in at a robust 16%. While a sequential slowdown from the +20% growth rates reported in each of the prior two quarters, Q1 backlog accelerated. This was perhaps the most positive development in the quarter.

 

Most importantly, the backlog accelerated at the same time the Sales/Inventory spread improved by 500bps. Is it in an ideal position? No. But it is definitely getting better on the margin.

 

One thing we liked on the call was Matt Rubel’s realistic view on input costs relative to what we’ve heard from other CEOs over the past two months. He noted the dynamics around trying to pass through higher prices to a soccer Mom who is buying shoes that her kids will outgrow in 3 months. Will any or all of the strategies work to mitigate margin risk? Time will tell. But those who win will be those with a clear process that looks beyond taking prices up on a like for like basis.

 

In the end, we’re taking our 2012 number down slightly to $2.00 due to a slightly higher tax rate.  We’re sitting here with a $22 stock. Based on our math, Saucony and Sperry alone are worth $12-$14. That suggests that the remaining business is worth less than $10.

 

PSS: When Boring is Exciting - PSS S 3 11

 

PSS: When Boring is Exciting - PSS Comp Trends 3 11

 

 


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