Are these Initiatives Enough to Fuel Wendy's Growth?

Can Image Activation and System Optimization do wonders for Wendy's?

May 7, 2014 at 4:31PM

With year-over-year capital returns of 48% and 45%, respectively, Buffalo Wild Wings (NASDAQ:BWLD) and The Wendy's Company (NASDAQ:WEN) have proven to be two of the better investments in the restaurant industry. Burger King Worldwide (NYSE:BKW) has also provided a substantial return of 45% to investors in the past 12-months.

In an effort to boost its profits, Wendy's has taken two bold initiatives. Let's see what these initiatives are, and how are they affecting the company.

The System Optimization initiative
Thus far, the biggest step the company has taken to drive its profits has come with the System Optimization initiative. With the program, which started in July 2013, Wendy's aimed to change its business to a franchise-based model. The company had a goal of reducing total system ownership from 22% to about 15%.

Last month, Wendy's completed its System Optimization initiative by selling 104 restaurants in Phoenix, Hawaii, Los Angeles/Palm Springs, and Albuquerque. The company sold 40 stores in the Phoenix region to Arizona Restaurant Company, 32 Los Angeles/Palm Springs outlets, 7 Hawaiian restaurants to Cotti Foods Hawaii, and 25 Albuquerque area restaurants to JAAB Restaurant Holdings. Under the program, Wendy's has sold 418 company-operated stores in 13 U.S. markets, primarily in the West.

Image Activation initiative
Under the Image Activation initiative, Wendy's is working on the reimaging of its restaurants in order to add more brand value to its stores. The company is in the process of reimaging 180 restaurants under its contemporary Image Activation restaurant design. It also has development plans for approximately 100 new restaurants. Wendy's is choosing operators with good track records for this transition.

Are these initiatives working?
A franchise-based business model lowers capital requirements for a business, which in turn increases its earnings and returns on equity. Moreover, it also helps a company generate stronger free cash flows, which it can use to enhance shareholder return in the form of dividends or stock buybacks.

Wendy's decision to transition into a franchise-based model is already proving to be a great decision for the company. Its fourth-quarter earnings testify to this fact. During the quarter, Wendy's posted net income of $33.1 million, up 25% from $26.4 million last year. One of the major reasons behind this net income increase was a reduction in costs, which fell 5% to $568.3 million.

Apart from this, the company expects earnings to rise this year as well. It expects earnings per share of $0.34-$0.36 this year while it hopes to report earnings of $0.29-$0.30 for last year.

Is Wendy's undervalued?

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Wendy's is trading at a forward price-to-earnings of 20.6, which is slightly lower than the valuations of of Burger King and Buffalo Wild Wings. Its price-to-free cash flow is also lower than those of its peers, which also suggests that it's cheaper than them in relative terms. Burger King appears to be rather expensive, but again, its earnings have also grown more than those of the other two companies.

Burger King and Buffalo Wild Wings
As a result of refranchising, Burger King was able to reduce its expenses by 86% in the most recent quarter. The company's low fat fries, Satisfries, have done a great job in the last few months, so the company has added the fries to its Kid's Meals as well. In the last year, the restaurant chain opened 670 net new restaurants and remodeled 600 stores. Recently, the company opened a new franchise in the Kingdom of Brunei.

Buffalo Wild Wings posted an increase of 73% in net earnings during its first quarter. Same-store sales at company-owned restaurants grew 6.6% and comparable sales at franchised locations increased 5%. The company enjoyed strong sales during February and March amid the Winter Olympics and March Madness.

In 2014, Buffalo Wild Wings expects to achieve net earnings growth of 25%. The restaurant chain has a long-term vision of operating 3,000 restaurants worldwide, which is why it's expanding its own stores and franchises.

Bottom line
The System Optimization initiative has done wonders for Wendy's. It has helped the company continuously reduce its costs, which explains why it is minting a lot of profit. The Image Activation initiative will also ensure that Wendy's restaurants are remodeled in a way that increases the company's brand image. On the whole, these two programs will further enhance the company's earnings in the years ahead. Wendy's has provided a strong projection for this year's earnings and it appears to be undervalued at this moment. This makes it even more attractive. In short, buy Wendy's.

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Waqar Saif has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings and Burger King Worldwide. The Motley Fool owns shares of Buffalo Wild Wings. 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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