WEN – BACK AS A COMPETITOR

WEN held its first post-merger quarterly earnings conference call yesterday. On its call, the company was able to boast its new management teams for both the Wendy’s and Arby’s brands and corporate, the fact that it is still on track to deliver $160 million in annualized incremental EBITDA by the end of 2011, and most importantly, that its Wendy’s company-operated same-store sales improved rather significantly to up 3.6% in the fourth quarter from down 0.2% in 3Q08. The bull thesis on WEN continues to stem from the fact that for an investor, there is huge upside in finding the next brand that is going to move from the mismanaged category to the operating flawlessly category. WEN’s 4Q results, primarily at its Wendy’s brand, demonstrate that the company is making progress toward moving to the more positive side of that continuum.

WEN management attributed the Wendy’s same-store sales improvement largely to the company’s successful launch of its Value Trio of sandwiches being offered at $0.99. Wendy’s launched the three value offerings in September and has seen sequentially better results since then. As the first chart below shows, Wendy’s increased focus on value enabled the company to finally post same-store results in the fourth quarter that were in line with those of its two main competitors after a long period of underperformance. The second chart below was included in Burger King’s investor presentation last week and really highlights Wendy’s underperformance relative to both BKC and MCD over the past three-plus years. If the Wendy’s line was updated to now reflect its 4Q U.S. same-store results, it would show a tick up to 2.8% on a 2-year basis. Although this would still fall short of both MCD and BKC’s 2-year performance, on the margin, it is an improvement. I think this second chart is important, however, because BKC included it in its presentation to highlight BKC’s relative performance, particularly as it relates to its outperformance of Wendy’s. For some time now, Wendy’s has not been a formidable competitor. As a result, BKC has most likely been more focused on gaining share from MCD, but in 4Q08, Wendy’s posted a higher comparable sales growth number than BKC in the U.S. Wendy’s sequential improvement is evidence that the concept is gaining share (the restaurant industry is a zero sum game), and that share gain appears to be coming at BKC’s expense.

Wendy’s same-store sales growth has been fueled primarily by its new value items, which have increased traffic, but at the same time, the company’s percent of sales being generated by its $0.99 menu has declined to 15% from closer to 20% a year ago. The company was able to achieve this by removing certain items from its $0.99 menu and subsequently raising the prices on those items. This lower 15% of sales level puts Wendy’s more in line with the 12%-13% and 13%-14% ranges given by BKC and MCD, respectively and will further help with the recovery of restaurant margins at Wendy’s.

WEN first stated its goal to generate $100 million in incremental annual EBITDA at Wendy’s by 2011 back in November. The company stated yesterday that it is still on track to improve the concept’s restaurant margins by 500 bps with about half of that amount coming from labor savings. Specifically, in the fourth quarter, Wendy’s delivered about 100 bps in restaurant margin improvement from labor efficiency and other restaurant operating expenses. These improvements were offset by higher food costs in the quarter but management stated that its food costs have started to decrease on YOY basis in 1Q09. Of the 500 bps, the company expects to generate less than 100 bps of savings from lower food costs. From a timing standpoint, WEN expects to achieve 160-180 bps of the total 500 bps of restaurant margin improvement in 2009. Management stated that although it is seeing a decline in commodity costs from its initial guidance of up 2%-4%, its margin guidance does not include the expectation that food costs moderate so any further decline in commodity costs would provide upside to that 160-180 bp range.

WEN also stated that it is on track to deliver on its goal to reduce corporate G&A on an annualized basis by $60 million by the end of 2010. Importantly, by the end of 2008, WEN had already realized over $25 million of this $60 million target, which is better than the $20M-$25M it outlined in early January.

The primary risk to the WEN story stems from the underperformance of the company’s Arby’s brand. During the fourth quarter, Arby’s system same-store sales declined 8.5%. Management attributed the poor performance to significant discounting being pushed by its competitors as Arby’s has an average check of about $7.50 versus its sandwich category competitors’ focus on $5 price points. The company thinks that its recently launched Roastburger sandwiches and other initiatives will help to drive frequency among its core users (which represent 50% of Arby’s sales). Additionally, Arby’s is testing new value items that it plans to roll out later in 2009. Although the Arby’s concept does not need to outperform in order for WEN to work, if Arby’s does not experience any improvement in sales trends, it could prove to be a drag on company earnings. Specifically, management commented that its mid teens EBITDA growth relies on positive comparable sales over the next couple of years.

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