ByThomas Finser:
Wendy's (
WEN
) remains an orphan in today's schizophrenic market. Despite recent
improvements with core operations, the addition of a new
world-class QSR management, continued leadership from activist
Nelson Peltz and the jaw dropping discount to NAV, few investors
have bothered to sharpen the pencil. The silence is deafening.
Wendy's remains loved by few, and forgotten by most.
In the following three-part analysis, I will demonstrate beyond
a reasonable doubt why present institutional apathy is
unsustainable. Given the discount to NAV, and the growing list of
catalysts, this stock is a goldmine for the patient few.
The first section will include a brief snapshot of WEN,
including a recap of recent history and a high level overview of
the secular trends in the QSR industry. In the second section (Part
II) due later this week, I will analyze the catalysts for unlocking
shareholder value. Part III will pull it all together through a
nuanced valuation approach that escapes casual cross-comparisons
(and most screening tools). Finally, I will conclude with a
discussion of "the knocks," risks and challenges facing management
and the business in general. In so doing, I hope to illuminate
facts from a fresh perspective and provide an alternate framework
for evaluating the long-term potential for Wendy's
shareholders.
Why Look at Wendy's?
Wendy's is an entrenched toll road business with scale and brand
resonance, whose growth is financed with other people's money and
is operated by highly incentivized agents. With a current EV of
$1.7 billion, patient investors have a triple-digit asymmetric
payoff opportunity and a 50% margin of error on NAV. Fortitude and
a minimum three-year time horizon are required.
- High quality assets selling at a conservative 50% discount to
current NAV
- Underappreciated long-term potential from new management
initiatives
- Market apathy nearing an inflection point
PART I: Company Overview
The Wendy's Company is a leading global quick service restaurant
business with over 6,594 locations worldwide. Menu offerings
include hamburgers, chicken breast sandwiches, salads, chili, fries
and frosty frozen desserts. As of January 1, 2012, Wendy's owned
and operated 1,417 restaurants and franchised an additional 5,177
locations through long-term agreements.
Financial Snapshot
- Market capitalization of $1.7bn (406m fully diluted shares).
EV of $2.7bn.
- 2011 annual sales of $2.4bn. Company owned stores accounted
for $2.1bn + $305m '11 franchise revenue.
- Net debt roughly $900m. $1.3bn LT debt maturing 2019 ($400m
cash). No significant off-balance sheet obligations.
- Decent operating cash flow of $178m '11 and $316m
EBITDA.
- Flat sales growth and GAAP operating margins of 7%.
Historical Context
From inception in 1969, Wendy's established a unique MO for
quality food and fresh ingredients. Co-founder Dave Thomas
emphasized made-to-order food at a time when the industry relied on
heat lamps and pre-made burgers. After Dave Thomas passed in 2002,
Wendy's entered a prolonged malaise caused by poorly executed
marketing initiatives and ill-conceived acquisitions. Though the
core Wendy's brand remained resilient, much of the energy and
excitement that propelled the franchise to iconic status began to
tarnish. If ever a company was in need of a leadership catalyst,
2007 Wendy's fit the bill.
This catalyst arrived in 2008 when private equity giants Nelson
Peltz, Peter May and Edward Garden acquired 20% control through a
well-timed merger of their floundering Arby's brand. Peltz quickly
initiated a brand revitalization and operational improvement
program. However, turnaround efforts were complicated by the
financial collapse and a prolonged recession.
Though Wendy's store traffic held up to peers, Arby's horrific
sales comps dragged down the conglomerate and distracted management
for the core. By late 2011, Peltz took decisive action by selling
81% of Arby's to Roark Capital. A new top-notch CEO was hired from
YUM! Brands (
YUM
) (Taco Bell, KFC, Pizza Hut) and new marketing and HR managers
were added to the roster. By mid 2012, Wendy's management and BOD
were, for the first time in years, fully aligned and committed on
re-igniting the brand through a long overdue investment. By this
time, Peltz and Trian accumulated nearly 30% of the stock.
Macro Backdrop
While Wendy's struggled with self-inflicted distractions, the
QSR landscape evolved. The prolonged economic malaise brought on by
a recession and changing consumer tastes accelerated two major
industry trends in U.S. out of home dinning.
-
Increased awareness of health/nutrition
and food quality. More consumers indicate preferences for
healthier options…everyone wants to be a foodie (think TV shows,
gourmet food trucks, and foodie pop culture). Consumers have
grown more adventurous, demanding quality ingredients and freshly
prepared foods. The new breed of fast casual restaurants is
recasting incumbent QSR brands by raising the bar on
quality/value perception. Panera Bread (
PNRA
) and Chipotle (
CMG
), for example, are winning the aspiring, quality conscious
consumers with handmade products in an upscale setting. Many
customers are happy to pay a 40%+ price premium for this
perceived quality.
-
Emergence of the new low-end
. With the economic downdraft, many consumers are cautious, often
trading down in price. To some degree of success, incumbent QSR
chains such as McDonald's (
MCD
) stepped up the low-price offerings in order to retain store
traffic. In addition, c-stores and grocery stores have entered
the market with competitively priced "to-go" food offerings,
often linking meal deals to gasoline purchases and other unique
promotions.
Given these secular shifts, many QSR brands remain challenged by
market bifurcation. Incumbents lacking the capacity to profitably
compete on the low-end or insufficiently capitalized to move
"upscale" in value perception will remain under pressure.
Competitive Differentiation
Though the above-mentioned secular trends are reconfiguring
"competitiveness" in the QSR space, Wendy's retains some key
attributes of competitive differentiation. Please note I have
defined competition broadly to the entire dinning out of home
category.
-
Quality
. While most QSR mega-chains rely on pre-made, microwaved food
assembly, Wendy's has the equipment and process infrastructure to
make food fresh to order with real ingredients. This subtle but
important kitchen infrastructure attribute plays to Wendy's
advantage with market bifurcation mentioned above.
-
Brand
. The Wendy's brand continues to resonate with consumers on key
metrics that matter most. Despite nearly 10 years of sub-par
marketing and chronic-under investment, it continues to outrank
competitors such as McDonald's.
-
Scale
. With over 6,500 locations worldwide, it has scale in
operations, purchasing and marketing. In such a dynamic industry,
incremental benefits of amortizing costs over a large network are
amplified overtime - especially during times of commodity
inflation and intensifying macro challenges. Larger QSR chains
can often rework the supply-chain to their benefit while smaller
regional restaurants are stuck with the Sysco (SYY) product
catalog.
-
Franchisee network.
Franchisees are a capitalist's dream. They provide virtually 100%
of the capital investment, operation oversight, staffing etc.,
with contractual 20-year inflation adjusted royalty kickbacks to
the franchisor. Franchisees are highly motivated to succeed, and
switching costs are enormous given the multi-million,
multi-generational sunk cost in building new stores. With 5,177
franchised units, Wendy's owns a considerable asset which
provides structural and strategic benefits few restaurant
businesses will achieve. This allows for greater financial
flexibility and reinvestment opportunities.
Despite years of underinvestment, the core Wendy's brand remains
robust as seen in the Zagat data. One can't help but notice the
parallels to Roberto Goizueta's New Coke fiasco, albeit on a
smaller scale. The New Coke fell at once with one colossal product
flop whereas Wendy's gradually tarnished in recent years from
self-inflicted cuts. Anytime there is decoupling of this magnitude;
where the brand remains active in the hearts and minds of consumers
despite company missteps, one can't help but recognize the presence
of an irreplaceable intangible asset. Paradoxically, temporary
brand mismanagement can sometimes reveal hidden strengths of
intangible assets. The continued top Zagat rankings are proof that
Wendy's still has the magic.
In the next section (Part II), I will expound on the catalysts
and explain the steps being taken to reignite the Wendy's
brand.
Disclosure:
I am long [[WEN]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
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