Wendy’s Is on the Right Track

Wendy’s has significant growth potential for several different reasons.

Jun 20, 2014 at 3:08PM
Wen

Wendys.com

High unemployment and intense competition are two external risk factors Wendy's (NASDAQ:WEN) lists on its 10-Q filing, and they're both legitimate threats. However, Wendy's has set itself up for long-term success. One of its recent high-priority initiatives is brand relevance, which could pave the way for long-term investor rewards.

North American comps growth
Wendy's has five growth opportunities for improving brand relevance. The first is to drive North American comps sales, or sales made at restaurants that have been open for at least 15 months. In order to drive comps higher, Wendy's aims to improve its core menu through innovation. When it comes to product innovation, Wendy's made noise with its Pretzel Burger in 2013. Wendy's hasn't had a success that big since, but the success of the Pretzel Burger demonstrates the company's innovative potential.

Wendy's hasn't been performing exceptionally well in North America. First-quarter comps increased just 0.7%. One potentially concerning result is that company-owned restaurants have outperformed franchised restaurants, with comps growth of 1.3% and 0.6%, respectively. This is concerning because Wendy's is always moving closer to a full-franchisee model. At the moment, it has 5,546 franchised locations and 1,001 company-owned locations. In the year-ago quarter, it had 5,374 franchised locations and 1,183 company-owned locations.

On the positive side, Wendy's completed the sale of 174 company-owned restaurants to franchisees in the first quarter, and it has now sold a total of 418 company-owned restaurants to franchisees. This has led to its cost of sales dropping to $374.2 million from $460.8 million in the year-ago quarter.

The reason for the decline in cost of sales (a good thing) is because franchised restaurants' revenue and expenses tied to food sales are no longer booked on Wendy's corporate financial statements. Instead, franchisees pay Wendy's a franchise fee (revenue for Wendy's) and royalty fees (greater of 4% of Gross Sales or $1,000 per month). This business model leads to lower revenue but higher profit margins -- a net win. On a related note, first-quarter net income came in at $46.3 million versus $2.1 million in the year-ago quarter.

Image Activation Program
Wendy's Image Activation Program pertains to the modernization of restaurants. To belay any fears of company-owned restaurants outperforming franchise restaurants for comps growth, much of this had to do with the Image Activation Program. Simply put, if you spot a remodeled Wendy's, it's likely a company-owned restaurant. It's possible, if not likely, that the majority of franchised restaurants will modernize their restaurants at some point down the road as well. 

New restaurant growth
Currently, Wendy's is primarily based in the United States and Canada. However, Wendy's hungers for international expansion. This likely relates to the success Burger King Worldwide (NYSE:BKW) has seen internationally after daring to spread its wings. For example, in Burger King's first quarter, it saw comps growth in the U.S./Canada (.01%), EMEA (4.8%), LAC (4%), and APAC (3.8%). For those last three, that's Europe/Middle East/Africa, Latin America, and Asia Pacific.

Burger King has also anticipated future trends well. It has seen the rise of the health-conscious consumer in the United States and planned on setting up shop in other regions as well. It will likely continue to move in this direction. The company's first quarter might provide a clue.

In Burger King's first quarter, here are the following moves for net restaurant growth: U.S. (closed 43), EMEA (opened 29), LAC (opened 4), and APAC (opened 20). At the moment, Burger King has the vast majority of its restaurants in the United States, but that could change down the road.

The point here is that Wendy's is likely to follow a similar pattern, and it's earlier in the process. Given Burger King's success abroad, this is a positive for Wendy's investors.

Expanding dayparts, mobilization, and earnings growth
Not much detail has been provided by the company here, but it is pretty simple. If Wendy's sees that one location is performing well for a specific daypart, then it might expand that daypart for that restaurant. This pretty much comes down to an increased focus on individual restaurant performances.

In regard to mobilization, you won't see any Wendy's restaurants on wheels. Instead, this pertains to Wendy's making its brand more accessible through mobile devices. This isn't an advantage over a competitor since it's a commonplace initiative throughout the industry. It's more to stay on par with peers.

In regards to valuation, Wendy's is currently trading at 39 times earnings, which might seem expensive, but the long-term earnings-growth picture looks healthy: 

Wen

Source: Nasdaq.com

The Foolish bottom line
Overall, Wendy's is cutting costs by becoming even more weighted toward the franchisee model. This should continue to aid the bottom line. For comps growth, the company's Image Activation Program has proven to be effective. Therefore, it should be utilized more going forward. Wendy's has also proven to be innovative, which can also help comps in the future. As far as new restaurant growth, there is untapped potential internationally. Expanding dayparts and increasing mobile exposure should be seen as gravy right now. Wendy's knows what it's doing, and given the company's strategies, it should be primed for long-term success.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide. 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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