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WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY?

Who is going to stir the pot on WEN?

 

Over the years, Trian Partners has been extremely successful at creating value from mispriced securities.  In the almost two years since creating the Wendy’s/Arby’s Group, it has now created one of those mispriced equities.  Can Trian and senior management fix WEN again?  Our sum of the parts analysis concludes that WEN is right back where it was in 2005 – except this time, there is no value in the current security for the Arby’s brand.

 

In 2005, Trian and a host of other high profile hedge funds, put pressure on Wendy’s management to unlock value by allowing the market to value the separate parts of the company (resulting in the spinoff of Tim Horton’s).  Almost two years after the merger of the Wendy’s and Arby’s’ brands, the company finds itself right back in the same position.  In 2005, the Tim Horton’s brand accounted for more than100% of the value of the equity, as compared to today when the Wendy’s brand accounts for more than 100% of the value of the company. 

 

Over the past two years, management has done a commendable job restoring Wendy’s margins despite a very sluggish overall sales environment.  Ironically, at the time when Trian was pressuring Wendy’s management to spin off Tim Hortons’s, Trian pointed to the higher margins at Arby’s as proof of the company’s success as operators.  The relatively lower and declining margins at Wendy’s, at the time, acted as evidence of a concept that was being mismanaged. 

 

Given the quick turnaround in restaurant-level margin trends at Wendy’s, it would seem that Trian was correct in its conclusion that the concept was being mismanaged.  In the most recent quarter, the progress at the Wendy's brand was evident, but Arby's trends continued to decelerate and are overshadowing the company’s overall performance. 

 

Arby’s restaurant margin, which closed out 2007 at an impressive 19.7%, has since declined to 10.8% in the most recent quarter, not much higher than Wendy’s reported 10.1% restaurant margin in 1Q08, just before the two companies announced the merger.   The obvious conclusion would be that WEN management lost its focus on Arby’s while working to turnaround Wendy’s.  That being said, it is important to remember that Arby’s performance was already suffering when it merged with Wendy's in September 2008, and the economy has exasperated the declines at the concept.

 

WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY? - arbys1

 

The recent sales trends are somewhat disappointing.  Company-operated same store sales at Wendy's turned negative in April to -0.5% (excluding a negative fiscal month calendar shift from Mother's Day) from +0.2% in 1Q, while Arby's company-operated trends remained very negative, at -8.4%, albeit with traffic up 4% and check down about 12%.

 

This -8.4% and positive traffic in April marks a significant improvement from the first quarter when company-operated same-store sales declined 11.6%.  Management attributed the sequentially better trends to the systemwide launch of the Arby’s $1 Value Menu in April, combined with national advertising beginning on April 11.  During the weeks when the company advertised its $1 Value Menu nationally, transactions improved to +7%.    And, as management correctly pointed out on its 1Q10 earnings call, “getting more customers into [its] stores is the first step in successfully turning around the Arby’s brand.”   

 

The company expects that the everyday value offering will lead to continued improvements in the second quarter as awareness grows.  Investors seem less convinced as WEN is currently trading down nearly 8% since reporting 1Q10 results.  Arby’s business is in free fall, relative to same-store sales, AUV and margin trends (shown below).  The deteriorating trends at Arby’s are overshadowing the improvements at Wendy’s.  Based on my sum of the parts analysis (also shown below), which assumes continued margin expansion at Wendy’s in FY10 (though not to the same magnitude as we saw in 2009) and continued margin erosion at Arby’s, WEN is being undervalued.  In fact, at its current price, it would seem that investors are getting Arby’s for free.  Given the current trends at Arby’s, this might not seem like too much of a bargain, but my numbers also suggest that WEN’s current price does not reflect the true value of the Wendy’s concept alone.

 

WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY? - wen sotp

 

As I said earlier, Trian Partners has been extremely successful in the past creating value from mispriced securities.  No, I do not think WEN will spin off Arby’s any time soon but the company will work to address the issues at Arby’s.  If Arby’s shows some sign that it has at least bottomed, WEN should reflect the full value of Wendy’s, which would suggest a move higher of nearly $2.  The potential longer-term upside is reliant on management’s ability to return Arby’s margins to peak levels.  I don’t think this will happen in the near future but we have seen what management has been able to accomplish at Wendy’s in a short amount of time.  Time will tell.

 

WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY? - arbys sss

 

WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY? - arbys auv

 

WEN - UNDERVALUED YES, WHERE IS THE OPPORTUNITY? - arbys rop

 

Howard Penney

Managing Director


Athletic Apparel: Holding Pattern

Athletic Apparel: Holding Pattern

Athletic apparel sales seem to be in a holding pattern, though the Athletic Specialty channel is outperforming by a country mile.

 

- We’d best characterize Athletic Apparel sales – per data released today (per SportscanINFO) – as being in a holding pattern. On one hand, the week showed a 500bp acceleration in sales. That’s great, but we think that the 3-week trend is more relevant, and that did not budge much from numbers we’ve seen in prior weeks.

 

- There continues to be a notable divergence between channels, with the Athletic Specialty channel outperforminig by a country mile. The Mass and Family channels did not fare well at all. Good for Dick’s, Hibbett, Foot Locker, Finish Line, etc…

 

- Every major brand posted an increase in its week-to-week delta, including Nike, Adidas, and Under Armour. Under Armour in particular is recovering nicely from a trough it hit 6-7 weeks back as it finally returned to positive sales growth. Adidas accelerated its upswing, which adds to its momentum in the US with Reebok toning footwear. Columbia and The North Face benefitted from strong outdoor category sales indicating the selling season for outerwear may be getting longer.

 

Athletic Apparel: Holding Pattern - 1

 

Athletic Apparel: Holding Pattern - 2

 

Athletic Apparel: Holding Pattern - 3

 

Athletic Apparel: Holding Pattern - 4

 

Athletic Apparel: Holding Pattern - 5

 

Athletic Apparel: Holding Pattern - 6

 

Athletic Apparel: Holding Pattern - 7

 

Athletic Apparel: Holding Pattern - 8

 

 

 


HOT CONSENUS SAYS IT WILL BE LIKE LAST TIME

JPM – generally a good proxy for consensus – issued pretty aggressive estimates and price target.

 

 

The sell side seems to have jumped on the momentum bandwagon lately.  Maybe it’s me – they may have always been mo – but with the huge run up in many gaming/lodging/leisure stocks, it seems that price targets are being raised by alarming magnitudes and with assumptions that stretch the bounds of rationality.

 

My friend over at JPM recently raised his price target almost 20% to $64 or 40%+ higher than the current price.  The analyst uses a sum-of-the-parts derivation to reach that price target.  Anna and I (mostly Anna) will tear those assumptions apart in a later post.  In this post, we are taking a look at just the estimates.

 

The chart below show’s JPM’s EBITDA and RevPAR estimates.  RevPAR is projected to grow 7%, 8%, and 8% in 2010, 2011, and 2012, respectively. 

 

HOT CONSENUS SAYS IT WILL BE LIKE LAST TIME - JPM estimates1

 

Pretty aggressive in our opinion and not surprising based on the prior recovery in 2004-2007.  Indeed, in looking at the next chart, one can see that it took 5 years to recover to peak RevPAR.  Using JPM’s own growth estimates implies a 5 year recovery period to 2012 to regain peak RevPAR.

 

HOT CONSENUS SAYS IT WILL BE LIKE LAST TIME - trailing revpar yoy change

 

We have several issues with the 5 yr return to peak assumption:

  • Unemployment – In a recent note, we showed the growing decoupling between GDP and RevPAR in favor of a tighter relationship with Unemployment.  We suspect that the decoupling began to take place as government spending as a percent of GDP exploded beginning in 2008.  The problem is that unemployment has not moderated on the same path as it has in previous recoveries and certainly not in the last one.  Note in the chart below that unemployment peaked at 6% during the last cycle and improved quickly.

HOT CONSENUS SAYS IT WILL BE LIKE LAST TIME - GDP UNEMPLOYMENT

  • Housing – We’ve shown that accelerating housing prices were a big component of the explosion in consumer spending from 1.  Even during the last recession, housing prices held and provided a buffer to the downturn.  The latest downturn was caused by the housing bubble burst, and we remain pessimistic regarding a v-shaped housing recovery.
  • Pent-up demand – We did not expect RevPAR to turn as quickly as it did but we cannot help but think that a significant part of it is just pent-up demand.  We’ll see over the coming months.
  • Sovereign debt issues – Our Macro team remains negative surrounding the impact of all of the sovereign debt issues – including our own – on interest rates and the global economy.  Neither would be good for hotel demand.

For these reasons, a recovery similar to 2004-2007 is unlikely, in our opinion.  Unfortunately, it appears investors are banking on it.


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MONTHLY STRATEGY CALL: BEARISH ENOUGH ON SPAIN?

MONTHLY STRATEGY CALL: BEARISH ENOUGH ON SPAIN?

One of Hedgeye's Q2 Themes, Sovereign Debt Dichotomy is a call for an accelerating divergence between the countries with strong, liquid balance sheets and those with the largest debt issues. Furthermore, we called for and have seen a widening performance spread between the equities, bond yields, currencies and CDS of these countries.

On this month's Hedgeye Strategy call focused on one of the weaker countries, and the 9th largest global economy, Spain. We have gone into detail on why we see the market as not bearish enough on Spain, and more importantly, why you should be.

In addition, we updated you on our other two Q2 Themes:

  • April Flowers/May Showers - We expected and have seen U.S. equities lock in intermediate term highs as bonds break down to lower-highs. We have a very healthy degree of skepticism of Government, Politicians and the market's current levels and we are managing risk accordingly. As we think about the setup for the S&P 500 over the next three months, we observe 15 major headwinds for the market, the economy, interest rates, commodities, and the American consumer. Bearish on U.S. equities.
  • Inflation's V-Bottom - We are currently at generational lows of global inflation. As such, we continue to expect the global median inflation rate to accelerate meaningfully. Domestically, we believe CPI will accelerate sequentially throughout Q2, peaking at +3% Y/Y. We expect that and an impending rate hike to continue to be priced in the bond, currency, and commodities markets. We expect it to be priced into the equities markets last. Bearish on 1-3 year U.S. Treasuries.

We’ve resolved the technical error with the link in the previous email, so to hear the podcast for yesterday’s call, click here: https://www.hedgeye.com/feed_items/7923. The link to the accompanying presentation is here as well: http://docs.hedgeye.com/Hedgeye Q2 Themes and SPAIN May 18 2010.pdf.

 

Enjoy,

 

The Hedgeye Macro Team


MONTHLY STRATEGY CALL: BEARISH ENOUGH ON SPAIN?

MONTHLY STRATEGY CALL: BEARISH ENOUGH ON SPAIN?

One of Hedgeye's Q2 Themes, Sovereign Debt Dichotomy is a call for an accelerating divergence between the countries with strong, liquid balance sheets and those with the largest debt issues. Furthermore, we called for and have seen a widening performance spread between the equities, bond yields, currencies and CDS of these countries.

On this month's Hedgeye Strategy call, we focused on one of the weaker countries, and the 9th largest global economy, Spain. We have gone into detail on why we see the market as not bearish enough on Spain, and more importantly, why you should be.

In addition, we updated you on our other two Q2 Themes:

  • April Flowers/May Showers - We expected and have seen U.S. equities lock in intermediate term highs as bonds break down to lower-highs. We have a very healthy degree of skepticism of Government, Politicians and the market's current levels and we are managing risk accordingly. As we think about the setup for the S&P 500 over the next three months, we observe 15 major headwinds for the market, the economy, interest rates, commodities, and the American consumer. Bearish on U.S. equities.
  • Inflation's V-Bottom - We are currently at generational lows of global inflation. As such, we continue to expect the global median inflation rate to accelerate meaningfully. Domestically, we believe CPI will accelerate sequentially throughout Q2, peaking at +3% Y/Y. We expect that and an impending rate hike to continue to be priced in the bond, currency, and commodities markets. We expect it to be priced into the equities markets last. Bearish on 1-3 year U.S. Treasuries.

To hear the podcast for yesterday’s call, click here. The link to the accompanying presentation is here as well: http://docs.hedgeye.com/Hedgeye Q2 Themes and SPAIN May 18 2010.pdf.

 

Enjoy,

 

The Hedgeye Macro Team


ANOTHER POSITIVE DATA POINT FOR YUM

The double down is here to stay, but I think I might get ill if I took a bite of this beast….

 

KFC has elected to keep the Double Down on the menu “indefinitely”, according to media reports.  The product has attracted a surprising level of attention and Javier Benito, executive vice president of marketing and food innovation for KFC said, “our plans were to feature the product only through May 23, but millions of Double Down fans have spoken and we won’t disappoint them.” 

 

YUM has already been making headlines this week with the rollout of Taco Bell’s new $2 combo meal promotion.  I view the continuation of the Double Down and the $2 combo meal as positive data points for YUM from a sales perspective.

 

ANOTHER POSITIVE DATA POINT FOR YUM - dd kfc

 

Howard Penney

Managing Director

 


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