Wait On Wendy's To Deliver

By Ryan C. Fuhrmann | September 02, 2011 AAA

Fast-food restaurateur Wendy's (NYSE:WEN) reported second quarter results earlier in the month that saw modest sales growth and minimal profit generation. The company has ambitions to grow its store base internationally, but still has work to do to build investor confidence that significant cash flow production and sustainable bottom-line growth is on the horizon. (For more check out How To Analyze Restaurant Stocks.)

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Second Quarter Recap
Total company sales advanced 2.5% to $622.5 million and consisted of 2% restaurant sales growth (87% of total sales) and 4% growth in lucrative franchise revenue (13% of sales). Comparable store sales at the company-owned restaurants in North America improved 2.3%. Its total system of stores, which includes company-owned and franchised locations, also saw a same store sales increase of 2.3% as the franchised locations grew comps at the same rate as the company-owned units. The system ended the quarter with more than 6,500 stores, 333 of which exist outside of North America. Management detailed it is targeting locations in Russia, Brazil and China.

Costs outgrew sales, rising almost 5% to $575 million. As a result, operating profit fell almost 20% to $47.4 million. Backing out interest and income tax expense, reported net income came in at $11.3 million, or 3 cents per diluted share.

Full-Year Outlook
Wendy's provided EBITDA guidance in a range of $330 million to $340 million. Domestically, it plans to open 20 stores and 45 franchised locations and also expects to franchise 45 international units.

Analysts currently project sales of $2.5 billion and earnings of 15 cents per share. Comparability with last year is limited as the company is selling its chain of Arby's restaurants to a private equity firm. It expects the deal to close during the third quarter and estimates an aggregate deal value of $430 million.

Wendy's management has commitments to open an additional 700 stores outside of North America. The sale of Arby's will help it shore up its balance sheet that ended the quarter with $1.4 billion in long-term debt, though it also had nearly $500 million in cash. A reduction in debt should also boost cash flow generation as interest expense of $28 million ate up more than half of Wendy's operating profit during the quarter.

There is definite potential in Wendy's given the sale of Arby's removes a distraction (and losses) and the company has ambitious international growth goals. But at this point, this potential has yet to flow to the bottom line in terms of sufficient profit or cash flow generation. Free cash flow should come in close to the 42 cents per diluted share reported last year, but will need to grow significantly to push the share price back into the double digits.

The Bottom Line
At this point, prospective investors may be best served waiting on the sidelines for tangible signs that international sales will take off and cash flow production will increase. Rival Yum! Brands (NYSE:YUM) looks like a safer bet on fast-food growth overseas, while Sonic (Nasdaq:SONC), AFC Enterprises (Nasdaq:AFCE), owner of the Popeye's fried chicken chain, and Jack in the Box (Nasdaq:JACK) all warrant consideration for domestic industry exposure. (For more on earnings, see Earnings Power Drives Stocks.)

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