The Wendy's Company WEN relies on menu innovation, technological upgrades, international expansion and re-imaging of units to drive incremental revenues. However rising costs and increased capital spending are headwinds.
In the third quarter of 2018 , Wendy's earnings of 17 cents surpassed the Zacks Consensus Estimate of 15 cents by 13.3%. The bottom line also soared 88.9% year over year, primarily favored by the positive effect of a lower tax rate from the Tax Cuts and Jobs Act of 2017. Increase in adjusted EBITDA also boosted the earnings figure.
Meanwhile, shares of Wendy's have gained 16.2% in the past year, slightly outperforming the industry 's 14.1% rally.
International Presence & Expansion Efforts Bode Well
Wendy's is still trying to reach the global restaurant count of 7,500 by 2020. The company's international business is thus poised to be a growth driver in the future. It has growth plans and partnerships in Argentina, the Philippines and Japan.
Also, the advancement of Image Activation and improvement in its restaurant economic model is enabling the company to make a notable progress with its new unit development goals. Significantly, Wendy's achieved total net new development of 97 restaurants internationally in 2017, mirroring 1.5% year-over-year growth. In the first nine months of 2018, the company opened 109 restaurants as part of its expansion endeavors. Further, it boasts a strong pipeline of projects, expected to help it achieve the net new restaurant development growth goal of 1.5% for 2018, worldwide.
Restaurant Re-Image to Drive Traffic
Wendy's remains on track to achieve at least 70% Image Activation goal for 2020 as part of its brand transformation initiative. This program has gained traction in the recent past leading to an increased traffic and higher sales at its restaurants. At the end of 2017, 43% of the global system featured the brand's new image. Interestingly, as a result of this re-imaging, customers have seen some bold designs and friendlier restaurant teams.
In 2017, Image Activation benefited the North America same-restaurant sales by 70 basis points and the company expects a 60-basis-point benefit in 2018. At the end of the third quarter of 2018, 48% of the global system was image activated. The company expects 50% of the global system to be image activated by the end of 2018.
Deepening Focus on Franchising - a Boon
Wendy's is benefiting from its transition to a franchised business model. In 2017, the company had several first-time builders and doubled the number of franchisees from 2015 by building new restaurants. Though the reduction in ownership has been weighing on the company's revenues over the past few quarters, we believe franchising a large chunk of its system will lower its general and administrative expenses, thus boosting its earnings in turn.
Moving forward, the company plans to continue facilitating franchisee to franchisee restaurant transfers through its buy-and-flip strategy. Such a move ensures that restaurants are in the safe hands of well-capitalized franchisees, committed to long-term growth. In 2017, Wendy's facilitated 540 Buy and Flip transactions with 130 in the fourth quarter. In third-quarter 2018, the company completed nine Franchise Flips. Per Wendy's, it expects to complete nearly 130 Franchise Flips in the ongoing year.
Rising Costs Hurt
The Affordable Care Act, commonly known as Obamacare, would persistently have an adverse impact on restaurant operators as the latter will have to continue shouldering increased labor costs, which in turn, might hurt margins.
Meanwhile, in order to compensate these costs, the company is taking steps to re-align and re-invest its resources. Though these initiatives are expected to benefit Wendy's over the long term, the same is likely to increase costs in the near term, denting margins in turn. Furthermore, the company anticipates labor inflation of roughly 3-4% and commodity inflation of around 1-2%. This apart, it would also have to intensify its focus on cost savings and driving same-restaurant sales in order to cope with these inflations.
Also, Wendy's would incur an additional capital expenditure in the coming years in a bid to boost the re-imaging program. This might lower its free cash flow in the near term. Though the company has transitioned into a franchise-based model that requires lesser capital expenditure, it will still take some time to reap benefits. In fact, the company expects a capex of approximately $75-$80 million in 2018.
Zacks Rank & Stocks to Consider
Wendy's carries a Zacks Rank #3 (Hold). A few better-ranked stocks in the restaurant space are BJ's Restaurants BJRI , Darden DRI and Dunkin' Brands DNKN , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .
BJ's Restaurants, Darden and Dunkin' Brands' earnings for the current year are expected to grow 64.5%, 16.8% and 16.5%, respectively.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report Darden Restaurants, Inc. (DRI): Free Stock Analysis Report The Wendy's Company (WEN): Free Stock Analysis Report Dunkin' Brands Group, Inc. (DNKN): Free Stock Analysis Report BJ's Restaurants, Inc. (BJRI): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research