Wendy’s’ stock has flat-lined for over three years and, after today’s presentation, we have become less positive on the next three years. Its going to be an uphill battle for WEN to hit its long-term target of high-single- or double-digit EBITDA growth over that period.
TRADE: While the new burgers continue to help lift same-store sales trends, the combination of beef inflation and lower long-term guidance limits the current upside.
TREND: We are cautious on this duration as rival brands continue to execute on their own remodel strategy. CEO Emil Brolick has admitted that, while menu innovation is important, the full benefit won’t come through until the asset base is upgraded.
TAIL: More than $3.7 billion is required to the Wendy's asset base, according to management. That's the figure needed to carry out an "Image Activation" at the 70% of the Wendy's system that is earmarked for extensive remodeling. The company's market cap is $1.99 billion. Its 2011 revenue came in at $2.43 billion. We do not have a view on the TAIL because there is a lot of uncertainty as to how the remodels will test. The math does not inspire much confidence.
The first question anyone need to ask is where is that money going to come from and when will the capital start to flow?
Coming into today’s presentation, we were of the opinion that WEN was facing a difficult environment over the TRADE (three weeks or less) and TREND (three months or more) durations. Over the longer-term TAIL, we expressed a positive view on WEN, giving the company the benefit of the doubt pending lessons to be learned as remodel testing initiative is undertaken over the next six months or so.
Currently, as we wrote above, we don’t have a view on Wendy’s over the TAIL duration, but remain bearish on the TRADE and TREND. Wendy’s is behind the curve in the QSR space and requires a staggering amount capital investment to right itself.
Our thoughts on the Wendy’s presentation today can be boiled down to three key points. 1) In order to fix the asset base and make the concept competitive with category leaders, more than $3.7 billion will have to be spent. 2) The company effectively admitted that its older stores are substandard and are hindering any improvement in consumers’ perception of the Wendy’s brand. 3) Even if they current strategy that the company is testing is the correct one – and it may not be – it will be difficult to persuade franchisees to go along with the level of investment required to turn the brand around.
The table below shows the $3.7 billion and our calculation of that number. It should be noted that the total remodeling program will cost much more as that calculation only includes the 70% of Wendy’s restaurants that require “Image Activation”. Some additional stores require less extensive refreshing.
The question of where $3.7 billion is going to come from is especially bearish for WEN on the TAIL duration. We would not be a buyer of this stock today. While WEN endures this prolonged period of high capital spending, competitors will continue to proceed with already-well-underway remodeling programs that should, in our view, make the competitive environment for Wendy’s difficult.
The company’s “Recipe to Win” is based on four reimaging the restaurants, people, experience, and the food. Our main issue with this presentation is that the cost of this recipe, $3.7 billion, is going to significantly limit the earnings power of the company for a number of years.
ASSET BASE: The company has just over 6,200 restaurants in North America. The substandard condition of the units, relative to the competition, is hampering progress. The company estimates that a sales life of 25% will result from remodels. We would wait for that to be proven out and highly doubt, given the level of spending that the turnaround is going to require, that any upside will be missed from waiting on the sidelines. At this point, the anecdote of customers saying “this can’t be Wendy’s” in the remodeled stores is not a positive.
EBITDA: Management did lower the bar on guidance, as we had suspected it would, bringing long-term EBITDA growth expectations down to high-single-digits from the prior 10-15% range. We do not believe that high-single-digit EBITDA growth will happen for Wendy’s for at least three years.
SSS: The company is guiding to comps of 2-3% for this year. This almost doesn’t matter given the massive capital that the company is now if need of to turn the brand around. Over the longer term, management believes that an enhanced pricing strategy and marketing approach will help drive the top line.
BREAKFAST: No timeline was attached to the comments on breakfast. This has been a difficult ask for Wendy’s operators given the real estate challenges and the dominance of McDonald’s in this daypart. McDonald’s buying up billboards in test markets doesn’t help either.
COGS: Guiding to 4-5% basket inflation for ’12. Beef makes up ~20% of food and paper spend. The company is planning to offset by menu mix.
TAX RATE: The tax rate is expected to be between 40% and 42% this year.