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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