Wendy's Still Under Repair

By Sham Gad | August 16, 2010 AAA

Apparently not all cheap fast food establishments are benefiting from a growing cost-conscious consumer base. That is certainly the case for Wendy's/Arby's (NYSE:WEN), the nation's third-largest quick service restaurant company. Total revenues for the second quarter 2010 were $877 million as compared to second-quarter 2009 revenues of $912.7 million. Net income was $10.7 million, or three cents per share, including net after-tax special charges of $15.2 million. This compares with net income of $14.9 million, or three cents, including after-tax special charges of $12.4 million in the comparable 2009 quarter.

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A Long Turnaround
Wendy's continues to work at rebranding itself as the fresh fast food alternative. Consumers weren't biting, at least not in the second quarter. Storewide sales in North America were down by 1.7% while company-operated same-store sales decreased nearly 3%. The company continues to promote its fresh beef hamburgers along with a continued roll out of new items including premium salads and chicken nuggets. Yet those efforts have yet to materialize into profits and are apparently not likely to do so in 2010. The company forecast 2010 EBITDA to fall 3 percent to 5 percent from 2009. It previously forecast a low- to mid-single-digit percentage rate increase in adjusted EBITDA.

At the same time, McDonald's (NYSE:MCD) continues to thrive in this environment and just recently reported another impressive earnings quarter fueled by great acceptance of its new menu offerings, including smoothies and snack wraps. Same-store sales at Mickey D's were up nearly 5% in the quarter.

Brutal Price Wars
The competition in the fast food industry is as cut throat as ever. Arby's continues to suffer from 99 cent offers from rivals McDonald's, Burger King (NYSE:BKC) and Jack in the Box (Nasdaq:JACK). Outside the burger wars, Taco Bell, owned by Yum! Brands (NYSE:YUM) is currently experimenting with a $2 value meal offering. Valued at 80% of book, shares in Wendy's are clearly reflecting the work in progress at the company. Despite the discount to book value, assets that can't generate profits may not command fair value. (For more, see Value By The Book.)

On the other hand, McDonald's is changing hands at six times book, suggesting an opportunity in Wendy's if management can continue to execute. Yet even Burger King, which fetches 11.5 times forward earnings, trades for two times book. Ultimately, it all comes down to profits.

A Tough Road
Wendy's still has a lot of work ahead. In addition to improving the company's operations it has to find a way to compete in today's brutal pricing environment. (For more, see Value Investor's Handbook.)

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