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Wendy's Down on Breakfast Blues

By Mac Greer – Updated Sep 17, 2019 at 9:46PM

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Wendy's is giving breakfast another shot, and short-term pain could mean big long-term gain.

In this episode of MarketFoolery, host Mac Greer talks with Motley Fool analysts Emily Flippen and Andy Cross about some of today's business news. Moody's downgraded Ford's (F -2.35%) credit rating to junk status. It's not as bad as it might sound, but it's definitely not good for Ford, either. Ctrip (TCOM 0.48%) reported a great quarter, and the market sold the stock. Is this a buying opportunity for long-term investors? And, Wendy's (WEN -0.37%) announced plans to roll out breakfast to all U.S. locations next year. It's going to hurt in the short term, but if most other fast-food purveyors are anything to go off of, it'll probably mean good things for its future. Tune in to hear more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 10, 2019. 

Mac Greer: It's Tuesday, September 10th. Welcome to MarketFoolery! I'm Mac Greer and I am joined in studio by Motley Fool analysts Andy Cross and Emily Flippen. Welcome! How are we doing?

Andy Cross: Hey, Mac!

Emily Flippen: Doing well!

Cross: Doing well!

Greer: Good! We're apparently doing better than Wendy's. Wendy's having a rough day with investors. I want to say they're getting a Frosty reception. I'm sorry!

Cross: You should be, for that. 

Greer: It's a free show. We're also going to talk some Ctrip, the China-based online travel company. But we begin with Ford. Moody's downgrading Ford's credit rating to speculative or junk status on Monday. Moody's citing Ford's weak financial outlook. Now, Andy, I hear the word junk, and I think, sounds like things could be better. What does that mean for investors? What does that mean for Ford?

Cross: Otherwise known as speculative or high-yield. There are two basic main categories of debt. When companies issue debt into the markets, they can either be investment grade or non-investment grade. Non-investment grade, also known as junk or speculative or high-yield, because investors typically require higher-yielding, more payment, for the bonds that they get issued. Moody's, which is one of the major bond rating organizations, along with S&P Global and Fitch, which is a little bit smaller -- S&P and Moody's are two big ones -- they downgraded some of Ford's debt from just slightly investment grade to slightly non-investment grade. It's concerning, just because, when you think about what they have pointed out to why they've done this, and a lot of it is just the outlook. Ford's going through a major $11 billion restructuring. They're facing challenges globally. China especially has been a really tough market for them. So when Moody's looked at the business outlook -- which they still call stable, by the way, which is an important fact, I'll get to it in a minute -- but when they looked at that, they just said, "We don't think that the bonds that Ford issues are worthy of the investment grade that their other peers may get," so they just notched them down a little to just slightly less than investment grade. So it's not great for Ford the business. Moody's still did call the outlook stable, which is a good sign. But they've pointed to a lot of the challenges. So, from an investor side, for people who might own equity in Ford, it's not great. It doesn't mean that Ford's going bankrupt. It doesn't mean that they're going under anytime soon. It's just another little reference to the challenges that Ford faces as an organization.

Greer: When you say it's not great, though, it means Ford will have to pay more to borrow money. 

Cross: Yeah. If they go into the public markets -- now, Ford has a lot of different kinds of debt, because they have their Ford Motor Credit business as well, which is financing for consumers on the car side. So this is from the operating side. It depends on how you categorize the debt, but they have somewhere in the mid-$20 billion level of this unsecured debt that they've issued at the corporate side. And they have about $23 billion of cash on the books, so it's about the same. Again, another reason why Moody's said the business is stable. They have a pretty good balance sheet; they're just facing these operating challenges. 

But if they have to go issue debt, and they do constantly on the financing side, go into the markets, issue debt to get paid from investors, they will have to likely pay a little bit more for that debt. The bonds that are trading -- because, these bonds trade in the open markets now. Investors can buy these bonds. The yield for the pricing on those bonds went up a little bit. The yield on that price went up, which tells you that investors are expecting a little bit more, considering what Moody's did. 

S&P has not followed along yet. They might, but they haven't followed along yet. Neither has Fitch.

Flippen: When I think about high-yield debt in the context of an equity investor, so, an individual investor, when I think about what high-yield debt means to a company that I'm invested in, I actually separate it into two different categories. Ford falls on one side, but I'll touch on the other side in a second. So, when you look at Ford, you look at an industry that lacks a lot of growth that's extremely cyclical, and it's an industry that sometimes faces really high, immediate headwinds. So, with a company like Ford, like Andy mentioned, this is a car company that's really been underperforming for a while, and it's a company that, as an equity investor, doesn't look attractive; as a debt investor, probably doesn't look attractive. 

Then, there's this whole other category of high-yield debt issuers. You have Netflix, who's notorious for issuing a lot of high-yield debt. Uber, Tesla, WeWork reportedly looking after this same market. And these are companies that are really, really high-risk for someone who is a debt investor; but as an equity investor, offer a lot of risky but exciting opportunities for growth. 

So, I would tell investors, when they see a company issuing high-yield debt, to try to separate which category it falls into. Is it a category like Ford, where it's happening because of issues in the underlying business and the industry it's operating in? Or is it a high-growth company that's operating in potentially a multibillion-dollar industry?

Cross: Yeah, it's a great point, Emily, because Ford, they're an almost $40 billion market cap organization. Concerns around their free cash flow generation, how fast they're growing. It's a cyclical company, grows at maybe GDP levels, and they've really struggled here. Obviously, much different. They do need to go into the markets to borrow that capital, so they require the funds from the debt that they do issue, much like Netflix has recently. But it's a much different organization, just because it's not growing nearly as fast, and their profitability picture is just not necessarily clear for Moody's to see what they want to see for them to maintain that investment-grade level.

Greer: Let's bring it back to the stock as we wrap up here. Shares of Ford down more than 40% over the past five years. Is it a buying opportunity? Or is it more buyer beware?

Cross: I personally think it's buyer beware. We actually sold it out of Stock Advisor in the past year. Just, looking at the prospects -- they're very capital-intensive; there's all kinds of macro headwinds right now... They're going through this major restructuring. They just brought in Tim Stone, the CFO. He came from Amazon and Snap, I believe. He's the first outsider, I think, since the 1940s, to be the CFO of Ford. So, I have faith that they will actually continue to go through this restructuring. They're in the process of laying off 7,000 people. They're trying to turn the ship. It's just, I see what Moody's is seeing. From the equity side, you have a dividend payment. They're going to try to buy back some stock, I guess. But the investments they have to make, it's going to be a slog for equity investors in Ford. So, I'm not using this as an opportunity to buy into the stock. 

Greer: Let's move on and talk China. Let's talk about the China-based travel company Ctrip reporting better-than-expected earnings and revenue, but the stock down a bit. Now, Emily, for those who don't know the name Ctrip, this is no small company. Market cap of around $19 billion. And when I read the headlines, I think, better-than-expected earnings, better-than-expected revenue, but the stock down a bit? What's going on?

Flippen: Well, you're living my life now, Mac. With all the Chinese companies I follow, even if you have a beat and a raise, it seems to be that the market is not appreciating it right now. There are a lot of macro trends with that, but also some factors about Ctrip itself. Despite posting an earnings per share of yuan 2.25 vs. yuan 4.07 expected, beating on revenue as well, the company still posted a bottom-line net loss. That was not a net loss attributable to shareholders, but a net loss attributable to a lot of their investments. Really, that was the black spot on the earnings report. Admittedly, the stock's not down as much as it could have been, the way that we've seen with other Chinese companies. 

What I found really exciting was the fact that they had year-over-year revenue growth of 19%, accelerating gross merchandise value growth for domestic hotels and air tickets, which is amazing, given the fact that we keep hearing about this Chinese slowdown. New economic numbers now reporting a slowdown in China again today. So, a lot of news right now saying maybe China is not the place to be, maybe China's not growing the way we expect it to. But Ctrip and other companies continue to prove that they're actually still making a decent amount of money. Despite the fact that China maybe isn't growing at the rate that many people expected it to, it's still posting above 6% GDP growth rates, depending on which projections you use. Compared to the U.S., which I think is about 2.5% to 3%, that's really impressive. And if you still think there are great opportunities in the U.S. with that GDP growth rate, you probably think that two-over with China. 

There's risk there, but Ctrip -- like you said, Chinese travel agency, while they do a lot of the business for internal domestic Chinese travel, international Chinese travel, they do have a lot of investments in the international space as well. They have Skyscanner investments, and they own Many American consumers might have used a platform of theirs without even realizing it.

Greer: Andy, once upon a time, we used to talk about Ctrip all of the time here at The Motley Fool. It was a Motley Fool recommendation. The stock was just a champ. Just crushing the market. But over the last five years, the stock's trading basically where it did five years ago. It's lost to the S&P. What do you make of Ctrip today? It's a much bigger company than it was when we recommended it back in the day. 

Cross: When you compare that to a company like Booking, formerly Priceline, a recommendation and a company that I like better than Ctrip right now, which actually has a nice investment into Ctrip, so they're benefiting, as well as other things -- but, Booking has beaten both the market and Ctrip over the last five years. So, probably a better place for investors to be invested. I think the points that Emily makes, Ctrip really is a benefit from what's happening over in China long term, and the amount of spending and travel that the emerging middle class and Ctrip will continue to do. It'll probably be in a good spot. The question is, will it actually return for equity investors? We haven't seen it for the last five years, and I still like Booking ahead of Ctrip at this point.

Flippen: I disagree. And I do own Ctrip, so take everything I say with a grain of salt. But, I have some numbers here for you, Andy. Only 6% of the Chinese population owns a passport right now. The market that they're operating in, their core domestic market, it's still really small in comparison to where it will be. The government issues 10 million new passports every year. In 2018 alone, travel abroad in the country increased 15% year over year. And in China, only 35% of people are high or middle-low class. These are the people who would ideally be the ones spending money to travel. That's only 35% of the population. But, travel is growing gangbusters right now in China. We see countries internationally having the issues of too many Chinese tourists now coming over. You'll actually see that Chinese tourists now, even though they have a lower percentage of their entire population traveling, are spending about the same amount as U.S. tourists. 

So, I still think the reason why we haven't seen it over the past five years is because the market is still catching up to where I think it can be. But looking to the next five years, it's hard to imagine that this company, with the investments that it has, given its dominant positioning in the Chinese market, and given the propensity for Chinese people to not only grow their position economically, but spend that money to travel, means that this, in my opinion, has much bigger growth opportunities than Booking.

Cross: I just think, you get Ctrip by buying Booking, too, and Booking's a cheaper stock. It's a larger company stock, but it's outperformed. And I think you're just buying a higher-quality company than Ctrip. But, you're right -- Ctrip has the advantages of playing in a much larger market. But, with Booking, at least you get some part of Ctrip when you buy into that stock, too.

Greer: Tomato, tomatoh. Speaking of, shares of Wendy's -- they have tomatoes -- down around 11% after Wendy's cut its 2019 outlook. Wendy's is ramping up spending as it prepares to roll out breakfast next year at all of its U.S. locations. It currently has breakfast at a few hundred of its U.S. stores. Now, Wendy's, as part of that, will hire an additional 20,000 employees. Andy, what do you make of Wendy's?

Cross: I used to own Wendy's stock back in the '90s, many years ago. I used to eat at Wendy's. I haven't eaten at Wendy's in a long time. I used to like the fish sandwich, actually. 

Greer: I didn't even know they had a fish sandwich. 

Cross: I don't think they do anymore. Which is one reason why maybe I haven't been down there.

Greer: You're not doing the single or the double. Frosty?

Cross: No. Not much on the Frosty, don't really eat meat that much these days. I like the fish sandwich. Anyway, back to the story. It's interesting the stock is down, because breakfast is the market for restaurants these days. I mean, McDonald's has really pushed the breakfast menu, and now it's their most profitable line of business. About a quarter of the traffic is tied to breakfast for McDonalds. It's very high-margin for the restaurant business. Wendy's hasn't really been in there. They have a few stores, Mac, as we were talking about, a few stores that offer breakfast. They're going to roll this out. It's going to take some investments, both from their side and their franchisee side. 

I think the concerns for investors is, when Wendy's talks about their allocation strategy, it's into the business, as a lot of companies do, and then share repurchases and dividends. So the thought may be that this might start to lower a little bit, perhaps, of the share repurchases, which has been nice for the stock. I don't think the dividend will be at risk. Does this ultimately hurt their cash flow? They were expecting free cash flow to be about $230 million this year. Take out $20 million now from that, essentially, more or less. So, maybe their free cash flow will not be as high as expected. So, shareholders looking through the near-term sell the stock off. But the long-term story for this, considering the other companies that are making investments and have made investments into breakfast -- Starbucks, Dunkin, Panera now, Chick-fil-A; Taco Bell even has breakfast. This is a place that Wendy's really has to be to compete. It's higher on the profit curve. It's just going to take some investments to get there.

Flippen: The sell-off, though, we can't downstate how much of an investment this is. Their former projections for same-store sales growth were in the range of 3.5% to 7%. Now they're negative 3.5% to negative 6.5%. These are really going to hurt the company over the short term. But we're really missing the bigger story here, which is the fact that they have planned on their menu a honey butter chicken biscuit. Now, anybody who is also from Texas might immediately think to themselves, "But wait a minute, Whataburger does the honey butter chicken biscuit." So, I will say this: If Wendy's can tap into the very lucrative honey butter chicken biscuit breakfast market, I think there's a big opportunity here.

Greer: Let's wrap up with this -- shares of Wendy's have beaten the market over the past five years. And, oh, yeah, they've beaten McDonald's, too. Take that, Mickey D's. I'm a Mickey D's shareholder.

Cross: At a couple of points, they have tried breakfast before. It hasn't quite worked. They tried it in 2007, tried it in 2012. Didn't work.

Flippen: The market's different now!

Cross: The market is totally different, and they do have an analyst meeting in October where they'll share more details. I'm looking forward to that. Maybe they'll give out some of those Frosties, Mac.

Greer: So, when you look at Wendy's compared to McDonald's, I just mentioned -- Wendy's market cap, around $4.5 billion; McDonald's market cap, $160 billion. I'm not saying Wendy's can become McDonald's. But, if they get this breakfast thing right, don't they have a lot of upside?

Cross: I don't know if it's a lot of upside. They do have upside, considering how we are consuming foods at restaurants. Breakfast is a big part of that nowadays.

Flippen: The honey butter chicken biscuit market alone is probably enough to justify the upside. 

Greer: [laughs] OK. So, desert island. Let's have it. We've got three stocks. You're on a desert island for the next five years. Ford, Ctrip, or Wendy's. What are you going with?

Cross: I'm going to go with Ctrip. Out of those three, I'll go with Ctrip.

Flippen: I'm going to go with Wendy's. I feel hyped after this conversation. I'm ready for some honey butter chicken biscuits. I'll definitely go with Wendy's. Why not?

Greer: OK, I like it! I'm going to be curious to see how the honey butter chicken biscuit -- that's a tongue twister -- fares against the Baconator. I would never bet against the Baconator.

Cross: They both sound delicious!

Greer: The Baconator, though, the branding's brilliant. Never underestimate the Baconator. OK, Andy, Emily, thanks for joining me!

Cross: Thanks, Mac!

Flippen: Thanks, Mac!

Greer: As always, people on the show may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery! This show is mixed by Austin Morgan. I'm Mac Greer. Thanks for listening! And we will see you tomorrow!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Andy Cross owns shares of Booking Holdings, Netflix, and Starbucks. Emily Flippen owns shares of International. Mac Greer owns shares of Amazon, McDonald's, and Netflix. The Motley Fool owns shares of and recommends Amazon, Booking Holdings, Moody's, Netflix, Starbucks, and Tesla. The Motley Fool recommends International, Dunkin' Brands Group, and Uber Technologies. The Motley Fool has a disclosure policy.

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Ford Motor Company Stock Quote
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The Wendy's Company
$18.69 (-0.37%) $0.07 Group Limited Stock Quote Group Limited
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