Wendy’s (WEN) was added to our SHORT bench as a result of our LONG thesis on McDonald’s. We still believe that it might be adversely affected by the resurgence of McDonald’s, but it’s not time to go SHORT on WEN yet.
Yesterday, WEN reported 2Q15 results, for the most part outperforming consensus, but as management put it, has room to improve on their value offering. The company-owned comp was +2.4% versus consensus of +1.7%, a 150bps decline YoY. This quarter was their toughest comp of the year at +3.9%, comps get easier in the 2H of the year. Total company revenue of $489.5mm beat consensus of $486.3mm, representing a decrease of -6.5% due to refranchising efforts. Company-owned restaurant level margins increased 40bps to 18.2%, beating estimates of 18.1%. Adjusted EPS came in at $0.08 below consensus of $0.09, representing an -11% decline YoY.
Reimaged stores are having a strong impact, seeing 10-15% sales increases post completion, with 40-50% of that flowing through. Newly remodeled stores drove 170bps of the system-wide same-restaurant sales growth of 2.2%, which was above estimates of 1.6%. Management stated they are continuing to see strong results from core menu items and LTO’s. Recently introduced a refurbished chicken sandwich featuring new marinade and antibiotic free chicken, in certain test markets and hoping they can bring it system-wide. The company is notably having difficulties with price and value on some items, and working to fix it with value bundles in the $4-$6 check range.
The company continues to invest in technology to improve customer interaction. They view Mobile Order & Pay and Self-Order Kiosks as a great ways to offset wage inflation, as well as improve the quality of the food and experience for the customer. Just staying on the wage topic for a moment, management was adamant that they do not, and their franchisees do not intend to pass a majority of this increase onto customers in the form of pricing. They will work on reducing staff, reducing hours, in general getting smarter around labor management. Management went as far as to say, “these wage increase will in the end hurt the very people they are intended to help.”
The hot topic in restaurants, the REIT was broached in this call, but largely pushed to the side by management. By 2017 they anticipate receiving $170mm a year in rental revenue, which is a strong dependent revenue stream they don’t want to get rid of.
WEN increased their outlook for 2015 adjusted EBITDA to $385mm to $390mm from its prior guidance of $375mm to $390mm, representing an 8% to 9% increase compared to 2014. The company also increased their outlook for restaurant operating margins by 50bps to 17% to 17.5%. EPS estimates remained constant at $0.31 to $0.33. The planned sale of 540 domestic company-operated restaurants is on schedule, and expected to provide $400mm-$475mm in pre-tax proceeds. Additionally, the company entered into an accelerated share repurchases transaction for approximately $165mm as part of a previously approved share repurchase authorization.
We continue to think that looking out 1-3 quarters WEN sales will start to take a hit from the resurgence of McDonald’s. Until that happens this company will perform in line with expectations, comping at the 2.0% to 2.5% range. When MCD starts taking share, WEN will not be immune, it seems like the first company to get value right will win this race, our bet is on MCD.
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Takeaway: RL is setting up to be a two-bagger, or the Mother of all Value Traps. We’re inclined to think the former. It’s all ‘bout mgmt. Stay tuned.
We said earlier this summer that we liked RL as a TRADE into today’s print. Fundamentally, the call played out – though we’re about flat on the stock.
Let’s get one thing out of the way…this RL quarter was horrible. Yes, it beat muted EPS expectations by $0.10. But revenue was down 5.3%, gross profit -7.1%, SG&A UP +4.3%, and EBIT/EPS down ~40%. Think it can’t get any worse? Think again, the cash conversion cycle is sitting at 171 days, which is 26 days worse than last year. Finally, capex is up 25% this year, which is the icing on a really bad tasting cake. Put ‘em all together – P&L down 40% and Balance Sheet +25%, and you get RNOA of 13%, down 1,000bp vs last year.
Then why are we incrementally warming up to RL? When it comes to consumer brands and retailers, some of the best longs we’ve seen (ones that double, and then double again) start with
a) positive rate of change in the balance sheet, which frees up cash to…
b) improve margins while investing in the content/Brand, and ultimately…
c) accelerate the top line. The stock will usually seem expensive early on in this process, and that’s where RL is today, as it’s trading at 17x a declining earnings stream.
We’ll very rarely give any company the benefit of the doubt for being able to turn such a value-eroding algorithm around – but Ralph Lauren is perhaps one of them. The reality is that it is a brand with an aggregate value at retail of $15bn, and as the company positions its resources around its core assets on a global scale, we should see growth return, and Brand footprint go through $20bn. Specifically, as it relates to the criteria above…
a) on the Balance Sheet we should see Capex coming down next year by 25%, or about $100mm as spending on SAP, which should subsequently take the Cash Cycle down by a minimum of 25 from here (that’s $200mm in cash)
b) on the Margin line, we should see a lift from the 11.5% where it’s targeted to come in for FY16. For the record, that’s the lowest margin level –by a third – since 2005 when it faced dilution from integrating licenses(most by Jones Apparel Group).
c) better productivity in company-operated stores and e-commerce alone could add $3bn to consolidated sales – nevermind better efficiency in wholesale doors.
When all is said and done, in 2-3 years we could be looking at $9.5bn in sales, 15% EBIT margin and $11-$12 in EPS. The CAGR that would require such growth (25-30%) would arguably support a 20-25x multiple on $11+ in earnings. That’s when RL becomes a two-bagger.
All that said, we have to get comfortable with one thing, and one thing alone – and that’s management. We outlined the risks to that part of the story in our recent vetting book [LINK: CLICK HERE]. Aside from the fact that RL has the seventh oldest CEO in the S&P – and one who is more active today than ever in the day to day operation of the company, there are six new divisional presidents who need to learn their own job as well as hire and subsequently motivate teams of expensive people to be productive. That’s not a 1-2 quarter phenomena.
We’re going to take RL up another notch on our Idea List, and will further vet the management angle before adding it to our Best Ideas.
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