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How many people passed up buying MCD at $15 or SBUX at $10 because they were unsure of whether or not the brand can thrive and generate the revenue and profits it once did. 

You can make up 100 reasons not to buy a stock and they may all be valid.  However, finding a true turnaround story requires the ability to look past the inconsequential noise and identify positive change and value creation in a company.

Just for a minute, put aside any baggage you may carry about WEN (however justified) and take a look into what could be for a brand that has been lost for the past ten years. 


Wendy’s is traded up 7.6% yesterday on volume of almost 18m shares (+111% versus the 30-day average).  The story appears to be gaining more traction on the Street, but it is still untold with 67% of the sell-side analyst community having a hold or sell on the name.   Trading up above $5 at the time of writing, I think it could go far higher.

As a practice, we don’t set target prices but, if I were going to dream a little, I would have a $10 number in mind.  What would it take for Wendy’s to get to $10?  Such a move would almost be McDonald’s/Starbucks-esque and, while I recognize that Wendy’s is not a category leader and competes in a more competitive industry, I think it is possible.

TOP LINE TRENDS

The Wendy’s brand is very healthy and its current trends of positive comps in 1Q11 speak to the health of the concept.  Currently, management is guiding to 1-3% for 2011.  What if those expectation prove to be conservative.  Unlike a brand like Burger King, Wendy’s has a very loyal and broad customer base.  There is a possibility that the national rollout of the new cheeseburger in 2H11 resonates with the loyal customers and sparks increased usage of the brand.  The burger patty will also allow the company introduce more new product using the name of founder Dave Thomas.  

If management expectations for same-store sales prove conservative, this could provide significant upside in the stock.  The only incremental information from today’s earnings release and conference call was that comps were positive in February and will be flat-to-positive for 1Q.  The stock reacted positively to this and I believe additional improvement in comps would likely instigate another leg up in the stock price.

AN ADVERTISING HOME RUN

It’s obvious to those close to the company that the company has struggled trying to find an advertising campaign that resonates with the consumer.  As I alluded to above, the use of Dave Thomas’s name in the new hamburger could be that undiscovered marketing boost the company needs.  The Wendy’s advertising message has not resonated as strongly since Dave Thomas passed away.  Naming the new burger after him will allow the company to bring back Dave’s name and promote a message of the company going back to the basics that Dave endorsed such as high quality food and a high level of customer service.  I’m not sure how this is going to play out, but reconnecting the Wendy’s core customer to Dave Thomas could bring incremental traffic.

Initially, the company has a new advertising campaign, starring Dave Thomas daughter Wendy, which has seen a favorable response.  While this is unlikely to cure all ills for the brand, it is a start and indicates to me that management is taking a measured and targeted approach to how they drive brand awareness and image going forward.

MARGINS AND PROFITABILITY

All of management’s attention being focused on repairing Wendy’s margins over the next few years spells good news for the future.  It is important to note that the current improvement in margins has come from better operations and not leverage from increased sales trends.  Wendy’s margins have recovered from 11.6% in 2008 to 15.5% in 2010.  If the current initiatives have an out-sized impact on same-store sales, the concept is perfectly positioned to capture the flow from the increased sales volumes.  In the past cycles, Wendy’s margins peaked out at 16.5% (+/-) and the concept was never really managed with a surgical focus on operations.  Given the lessons of past business cycles and the new focus management seems to have adopted, who is to say that Wendy’s margins can’t reach 18-19%?

THE SALE OF ARBY’S

Investing alongside Trian could provide some upside to expectations.  In this environment (and given how troubled the brand is) just the announcement that there is actually a deal for Arby’s will be a net positive.  The Arby’s brand can benefit from being a standalone organization too.  Like Wendy’s, Arby’s needs to return to its roots and focus on operations.  This can't be accomplished as a secondary brand in a bigger organization.

Upon completion of the sale of Arby’s the WEN balance sheet will be in much better position.  The freed up capital will allow the company to buy back more stock, pay a dividend and increase the company’s domestic and overseas growth initiatives.  In the end, I would err on the side that the partners at train will come up with a deal that benefits there significant equity stake in Wendy’s.

I realize that this narrative seems far-fetched; for Wendy’s to get to $10 in two years, the company EBITDA will need to grow by 40-50%.  Yes, that seems like a big number, but if I told you two years ago that Starbucks EBITDA was going to grow by 43% by the end of fiscal 2010 you would have laughed. 

In the short run, management’s confidence in the company’s ability to grow margins next year in the face of commodity headwinds is also good news.  Again, this could prove conservative, if sales trends improve significantly in 2H 2011.  In 2011, a simply menu and investment in point-of-sale technology, coupled with sales leverage, are key to management’s optimism and I believe, having seen this strategy play out before, that the strategy will be successful.  The outline I have provided here may be fanciful and there are certainly a lot of contingencies attached to the path to $10 for Wendy’s.  Nevertheless, I see significant upside for this stock over the next two-to-three years and $10 may not seem unreasonable.

I also feel very comfortable in being out of consensus.  The sell-side community is very much not behind the Wendy’s story. 

Lastly, being bearish on MCD is bullish for WEN.  If you believe (as I do) that MCD is too focused on driving incremental sales from selling beverages not burgers, when WEN will be one of the bigger beneficiaries.

THE WEN DREAM OF $10 - qsr sell side sentiment

Howard Penney

Managing Director