Shares of The Wendy's Company WEN are riding high on robust rental revenues, franchise-based business model, restaurant openings and menu innovations. Evidently, the stock has gained 10.5% in a year, outperforming the industry 's increase of 4%. However, higher labor and commodity costs along with capital spending might weigh on margins, going ahead. Let's delve deeper.
Wendy's remains on track to achieve its goal of 7,500 global restaurants by 2020. In this regard, the company's international business is expected to boost growth in the future. Also, it plans to expand and form partnerships in emerging markets of Argentina, the Philippines and Japan.
Further, Wendy's has long-term development agreements with franchisees in Singapore, the Middle East, North Africa, the Russian Federation, the Eastern Caribbean, Argentina, Japan, Georgia, the Republic of Azerbaijan, Ecuador and Chile. This apart, the company is exploring growth opportunities in China, Brazil and other key international markets. These less saturated emerging markets offer the company enormous growth opportunities.
Additionally, 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. The company is expecting 1% growth in 2018. Although the reduction in ownership has been weighing on revenues over the past few quarters, we believe franchising a large chunk of its system will lower Wendy's general and administrative expenses and thereby boost earnings.
This Zacks Rank #3 (Hold) company's brand transformation initiatives includes menu innovation, promotional offers and bold new packaging, intended toward boosting sales. Meanwhile, the practice of offering customized sandwiches on order and serving hamburgers made of never-frozen beef would continue driving the company's sales. Notably, the first quarter of 2018 marked Wendy's 21st consecutive quarter of positive same-store sales growth in North America, mirroring long-term strength and relevance of the brand.
Wendy's is likely to incur additional capital expenditures in the coming years to boost the re-imaging program. This, in turn, might lower free cash flow in the near term. Although the company has transitioned toward a franchise-based model that trims capital expenditures, it will take time to reap benefits. In fact, the company expects capital expenditures of approximately $75-$80 million in 2018.
In addition, Wendy's valuation looks a bit stretched when compared with its industry average. Looking at the company's price-to-earnings (P/E) ratio, which is one of the most commonly used valuation ratio and is best suited for evaluating restaurants, investors might not want to pay any further premium. The company currently has a trailing 12-month P/E ratio of 37.07. So, the stock is relatively overvalued right now compared with its peers, as the industry's average PE currently is 24.95.
Some better-ranked stocks in the same space are Wingstop Inc. WING , Dine Brands Global, Inc. DIN and Denny's Corp. DENN . While Wingstop sports a Zacks Rank #1 (Strong Buy), Dine Brands and Denny's carry a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here .
Wingstop has an impressive long-term earnings growth rate of 19.5%.
Dine Brands reported better-than-expected earnings in the trailing four quarters, with an average beat of 7.8%.
Denny's posted better-than-expected earnings in the preceding two quarters.
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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 Denny's Corporation (DENN): Free Stock Analysis Report The Wendy's Company (WEN): Free Stock Analysis Report DineEquity, Inc (DIN): Free Stock Analysis Report Wingstop Inc. (WING): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research