Is The Wendy's Co. Destined for Greatness?

Let's see what the numbers say about Wendy's.

Apr 3, 2014 at 9:04AM

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Wendy's (NASDAQ:WEN) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The charts you're about to see tell Wendy's story, and we'll grade the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Let's take a look at Wendy's key statistics:

WEN Total Return Price Chart

WEN Total Return Price data by YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(5.4%)

Fail

Improving profit margin

1,243.8%

Pass

Free cash flow growth > Net income growth

(12.5%) vs. 1,151.8%

Fail

Improving EPS

2250.9%

Pass

Stock growth (+ 15%) < EPS growth

108.8% vs. 2,250.9%

Pass

Source: YCharts. *Period begins at end of Q4 2010.

WEN Return on Equity (TTM) Chart

WEN Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

1326.3%

Pass

Declining debt to equity

4.4%

Fail

Dividend growth > 25%

150%

Pass

Free cash flow payout ratio < 50%

66.9%

Fail

Source: YCharts. *Period begins at end of Q4 2010.

How we got here and where we're going
Wendy's musters five out of nine possible passing grades today, which is a solid, but not overwhelming, performance. One major source of Wendy's weakness is falling free cash flow, much of which continues to be used to pay out dividends rather than build the business. However, Wendy's trailing-12-month free cash flow is more than twice as high as its net income, which should reassure investors who may worry about its near-triple-digit P/E. Wendy's shareholders have enjoyed strong growth over the past three years, and the stock has hit new peaks as the company's turnaround appears to be succeeding. Is this rebound sustainable, or will Wendy's growth be hampered by fundamental weaknesses and its shares suffer? Let's delve a little deeper to answer these questions

Wendy's reported better than expected revenue and earnings per share for its latest quarter on the heels of successful rollouts of two new pretzel-bread sandwiches (the Pretzel Bacon Cheeseburger and the Pretzel Pub Chicken Sandwich), part of an ongoing brand transformation that also includes restaurant remodels and brand redesigns. Wendy's limited-time menu offering, the Ciabatta Bacon Cheeseburger, is another effort to bridge the gap between the assembly-line fast-food fare of rivals McDonald's (NYSE:MCD) and Burger King (NYSE:BKW) and the fast-casual sandwich offerings of Panera Bread and other sandwich shops. However, Wendy's continues to suffer similar weaknesses in same-store sales as McDonald's and Burger King as consumers still view all three brands in a similar light.

Wendy's should ultimately benefit from its efforts, but only if it can properly publicize its new menu offerings -- it's not enough to just say the franchise is of higher quality than other drive-thru burger joints, it has to create that impression through positive word of mouth and taste appeal. Wendy's seems optimistic about 2014, forecasting same-store sales growth between 2.5% and 3.5%. The company does have some advantages in the fast-food sphere as well -- a QSR magazine study found that Wendy's boasts an average drive-thru service time of approximately 134 seconds, almost a full minute better than McDonald's average recorded speed of 189 seconds.

Fool contributor Michael Carter notes that the restaurant industry is expected to grow sales by nearly $100 billion from its 2010 total, to more than $680 billion this year, which should bode well for Wendy's and other fast-casual restaurant chains such as Panera Bread. Wendy's opened more than 380 franchised restaurants in 2013, which is about 5% of its 6,500 stores worldwide -- a rather impressive pace for a mature brand of this size. Fool contributor Brandy Betz notes that Wendy's faces similar new product launch issues as McDonald's, which has already been forced to slash prices on Mighty Wings by 40% to move the unwanted product. Burger King's low-fat fries and (not so low-fat) bacon sundaes have not faced similar consumer resistance.

Wendy's has never had much of a problem selling chicken-centric menu items, and the company seems well positioned to capitalize on increasing demand for chicken, which is relatively cheaper and perceived as healthier than beef. However, Popeye's Louisiana Kitchen plans to open 100 to 130 new locations in 2014, making it likely to compete with Wendy's in a number of regions for chicken-craving consumers.

Wendy's has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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Alex Planes has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, McDonald's, and Panera Bread. The Motley Fool owns shares of McDonald's and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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