INVESTMENT THESIS
Wendy’s Co. (NYSE: WEN). Fast-food chains have been hit hard by the pandemic as more customers stay home and prepare their own meals. However, investors appear to be looking beyond the near-term headwinds faced by restaurants and to gradual recovery over time. We note that Wendy’s has improved its ability to manage digital orders as a result of the pandemic, and that orders placed digitally also tend to be larger than other orders. To maintain positive elationships with franchisees, Wendy’s is offering favorable terms on royalty payments.
Our long-term rating is BUY.
RECENT DEVELOPMENTS
On November 4, Wendy’s reported adjusted 3Q20 earnings of $0.19 per share, flat with the prior year and $0.02 above consensus. The results reflected higher adjusted EBITDA offset by a higher tax rate due to a reserve for COVID-19. On a GAAP basis, the company earned $0.17 per share, down from $0.20 a year earlier.
Adjusted revenue rose to $452 million from $438 million in the prior-year period, and narrowly missed the consensus estimate of $454 million. The increase reflected higher sales at company-owned restaurants. Same-store sales were up nearly 8% in the U.S. following a 5.8% increase in the prior-year period. Adjusted EBITDA rose by $9 million to $119 million, above the consensus estimate of $112 million.
Below the line, interest expense increased to just over $29 million from $27.9 million. During the quarter, Wendy’s bought back 100,000 of its shares and the share count fell to 228 million from 235 million a year earlier.
The restaurant-level operating margin (revenue less food, labor and occupancy) rose 70 basis points to 16.9%, primarily reflecting a higher average check and lower ad spending. The consensus timate had called for a restaurant-level operating margin of 15.8%.
The company has suspended its 2020 guidance. As discussed in a previous note, for all of 2019, revenue rose to $1.7 billion from $1.6 billion, while EPS rose to $0.59 from $0.58. In 2019, Wendy’s spent nearly $218 million to repurchase 10.2 million shares.
FINANCIAL STRENGTH & DIVIDEND
Standard & Poor’s gives Wendy’s an investment-grade credit rating of BBB+. The restaurant-level operating margin rose to 16.9% in 3Q20 from 16.2% in the prior-year period, reflecting a higher average check and lower advertising spending.
RISKS
Key risks for Wendy’s include the duration of the pandemic, commodity inflation, fierce competition from McDonald’s and Burger King, and increased labor and utility costs. In addition, concerns about health and obesity could lead to reduced spending on fast food.
COMPANY DESCRIPTION
Wendy’s operates quick-service restaurants, with approximately 6,500 franchise and company-owned restaurants in the U.S. and 30 other countries. With a market cap of approximately $5.2 billion, the shares are generally considered mid-cap growth.
VALUATION
WHEN shares have posted a more than 86% total return since our upgrade to BUY on 11/25/16. We believe that our projected 2020 EV/EBITDA multiple of 14.2 inadequately reflects the higher margins and more stable revenue streams that occur when nearly all WEN restaurants are owned by franchisees. Our price target of $26 implies a multiple of 35-times our revised 2021 EPS estimate, above the average for small to midcap fast-food chains, which we believe is warranted by Wendy’s efforts to reduce G&A expense, pay down debt, improve profitability, introduce a breakfast menu and boost shareholder returns.
On November 17 at midday, BUY-rated WEN traded at $22.94, down $0.23.
Source: Argus
