2016's Surprise Burger Chain Stock Winner: Wendy's Co.

In The Motley Fool's Industry Focus: Consumer Goods podcast 2016 year-end special, analyst Vincent Shen and contributor Asit Sharma discuss the rise of Wendy's Co. (WEN -0.10%), the perennial No. 3 burger chain. Wendy's has generated a year-to-date total stock return of nearly 30%, following a 30% total return in 2015. To find out why the company is outperforming both larger and smaller peers, simply click the video below.

A full transcript follows the video.

This podcast was recorded on Dec. 19, 2016.

Vincent Shen: Asit, what was your pick for the consumer retail world for the company that really surprised you in 2016?

Asit Sharma: Vince, a stock that took me completely by surprise this year was none other than Wendy's. It's a perennial No. 3, world's third-largest burger chain, always trailing behind McDonald's (MCD 0.38%) and Burger King, which seem to be more in the conversation. Threw out some amazing numbers. Up 30% year-to-date on a total return basis. What's even more impressive is going back to Jan. 1 of 2015 -- the stock is up 57% on a year-to-date total return basis over these two years. Not something we usually correlate with the quick-service restaurant industry. Great margins since 2015, [with] the operating margins up over 50%.

Wendy's is doing this in three ways. It's impressing investors by its cost-cutting. It's also remodeling stores at a pretty good clip. You may remember that McDonald's went through a big store refresh a few years ago. Now, it's Wendy's turn. It's also refranchising, that is, selling corporate-owned franchises to individual owners and teams of owners. It's going to a model where it will look more like Burger King, which is 100% franchised. Wendy's, by the end of this year, will have 6,500 locations, and only 5% of those will be corporate-owned.

Shen: Yeah. You touched on a few things. I'll have to say, you mentioned the perennial third among the big fast food chains. Wendy's is definitely a company that I don't think we've touched on very recently on the consumer retail-focused segment of Industry Focus. That operating margin increase of 51% is really impressive in this space, especially some of the gains that the stock has been able to enjoy. It's definitely not something you typically see from what would generally be considered steadier, more stable names like a McDonald's, for example. You mentioned some things, like the new store remodeling, which, yeah, that's definitely a trend we saw with McDonald's as well. I think that has been very helpful in terms of helping to improve some of their foot traffic and store visits. What else has the company been working on, or have they been able to deliver to help boost the stock and see some of these strong results that they've been able to enjoy?

Sharma: They have a few strategies that they're employing. One is called "buy and flip". Back in the real estate boom, everyone was discussing how flipping homes might be a good investment. That was before it all crashed. Wendy's take on "buy and flip" is, instead of selling all the restaurants to new people or new franchisees, they're actually buying some of those back, but they're not holding on to them. So, Wendy's will buy a franchise unit, or several units, and then sell it to a different franchisee, which is perceived to be stronger, has better operating efficiency, and really knows how to manage the restaurants well. So, you can think of this as transferring its own restaurants from one franchisee to another. It's called buy and flip. I think it's a really good strategy.

Also, they are focusing on the basics. Many companies lose sight of the basics that pull in traffic from day to day. Wendy's is one which has quietly always adhered to quality service, speed, accuracy, the types of things that you now hear McDonald's talking about to regain customers. I think, this fall, Quick-Service Restaurant magazine, does an annual survey of all the major fast food restaurants in the U.S. This year, they ranked Wendy's No. 1. It has an average drive-thru service time of 169 seconds. It's the fastest drive-thru service in America. McDonald's comes in at about 208 seconds, and Burger King comes in at about 201 seconds. By focusing on the basics, and combining that with this larger strategy of getting its own units into the hands of franchisees, which reduces its own operating costs and brings in that great royalty and rental income. They put together this total picture that's boosted earnings and enabled the stock to take off. I want to cite one last statistic. For example, this last quarter, Wendy's had $49 million in net income. A year ago, they had $7.5 million in net income. So, they are really generating very impressive margin gains year to date.