The central tenet surrounding the bull case for Wendy’s which lies at the core of fixing the Wendy’s brand is the rollout of the new hamburger, beginning in 2H11. In January, our fundamental view of the stock was positive but, various red flags over the past six months have moved us to change that stance. The most important of which is this: we are now in 2H11 and there still appears to be issues with rollout of the new product.
It was reported on Friday that WEN is suing franchisees Lewis Topper and Jeffrey Coghlan and their WendPartners Franchise Group, alleging breach of contract and claiming they missed deadlines to buy and install bun toasters.
Lewis Topper and Jeff Coghlan are not insignificant franchisees. Both have been inducted into the Wendy's Hall of Fame and sit on the board of directors of OFFA - the Old Fashioned Franchise Association. According to the OFFA web site, the purpose of the organization “is to give Wendy’s franchisees a voice.”
The OFFA Mission states, “By positively representing the collective interest of the franchise community, we are reasserting the importance of franchisee involvement in the management decision making process. We are the only independent franchisee organization in the Wendy’s system. We are dedicated to preserving the values Dave Thomas instilled in Wendy’s franchisees from the beginning and to enhancing our members’ investment and profitability.”
The key part of the mission of OFFA is “enhancing our members’ investment and profitability.” The WEN system seems to be fully behind the idea of the new hamburgers, but there has been some disagreement around the type of toasters to be used and the appropriate testing of the product since January. Toasting the buns of the new hamburger was emphasized as a key component of the new product by management. An example of the one of the toasters that was tested by Wendy’s is pictured below. The machine costs approximately $10,000.
My guess is that the disagreement between management and the franchisees anchors on the question of who is going to pay for the equipment and whether or not the company has provided adequate evidence that the franchisees’ investment in the equipment will yield an adequate ROI. We believe that WEN management is on the right track, but the path to recovery is clearly taking longer than had been expected. As the news on toasters is hitting the tape, it seems that the breakfast rollout and remodel program are also experiencing some difficulties.
If the issue of paying for the toasting equipment could very important if it is a leading indicator for the larger discussion of which parties will bear what proportion of the cost of upgrading the asset base. While I think the company may have gone back to the drawing board for a better plan as it relates to the remodels, the most crucial question at this juncture is how much, if any, financial support the company will provide the franchise system in carrying out the program. Needless to say, the impact of these disputes has the potential to be a drag on EPS which may not be factored in to consensus estimates for 2012. Indeed, as MCD marches forward with its remodel program, the longer WEN takes to resolve these issues, the more share the company is likely to lose to MCD. The potential turmoil between the franchisees and management can only slow the potential progress of breathing life back into the Wendy's brand!
The street has been getting slightly more bullish of late, while the short interest in the stock is low but rising. MCD has been posting some strong sales results, which is likely making life more difficult for Wendy’s. Each issue that arises, whether it is around investing in new kitchen equipment, reaching consensus on breakfast, or the remodel program, pushes out the timeline for the turnaround further.
At Hedgeye, we define our investment stance on each stock on three distinct durations: “Trade”, meaning three weeks or less, “Trend”, meaning three months or more and “Tail” meaning three years or less. Given the issues that are weighing down WEN’s turnaround story, we are currently negative on a Trade duration, but bullish on the Tail.
Howard Penney
Managing Director
Rory Green
Analyst