Tickers in this Article: WEN, MCD, CMG, YUM
It's hard enough to make hay competing against well-run businesses like McDonald's (NYSE:MCD), and it's not made any easier by the intense price and brand competition that goes with the restaurant industry. What makes matters even worse for Wendy's (Nasdaq:WEN) is that the company is trying to establish itself as a "premium quick service restaurant (QSR)" in a market that just doesn't seem to want to pay premium prices for hamburgers and quirky sides like baked potatoes.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

First Quarter Results not Showing the Expected Progress
Perhaps I'm being unkind, but it feels like Wendy's is always a step or two behind the market. Based on first quarter results, it definitely seems that they're a step or two behind where the stock market thought they'd be.

Revenue rose 2% this quarter, with system-wide North American comp growth of 0.7%. That was well below the 3 to 4% improvement expected by many analysts, and it's made all the worse by the fact that the year-ago comps (-0.9%) should have been a little easier to outdo. Traffic trends weren't great, and it looks like the much-discussed W burger launch has not gone well.

Not only did Wendy's miss on revenue, but margin compression continues to be a problem. Restaurant operating margin fell 160 basis points, and at 11.8% Wendy's is way behind McDonald's (18.8%), Panera (Nasdaq:PNRA) (20%) and Chipotle (NYSE:CMG). Granted, higher beef costs are taking a toll ((as seen in the earnings reports of Tyson (NYSE:TSN) and Sysco (NYSE:SYY)), but it's not as though the food cost inflation is dramatically different from one restaurant chain to the next.

All in all, reported operating profit fell 25%, with EBITDA down about 13%. With this poor start to the year, management revised its EBITDA growth outlook from 1 to 4% to -3% to positive 1%.

SEE: Understanding The Income Statement

Does Wendy's Strategy Reflect Reality?
I believe that Wendy's has made some strategic missteps that have done some real damage to the company's brand and reputation. At a time when companies like McDonald's and Yum Brands (NYSE:YUM) focused on providing as much food as possible for a buck, Wendy's tried to hold itself out as a high-end QSR option. Unfortunately, while there does seem to be a real market for "premium value," customers seem to have a different kind of food in mind - more along the lines of Panera's offerings.

I'm also a little skeptical on the company's expensive store upgrade program. Although I don't doubt management's projections for improved sales, I'm not sure an expensive program with a five to seven year payback period makes a lot of sense when there are others issues to address.

One area where I do agree with management is in its efforts to build out its breakfast offerings. This is a no-brainer for almost every QSR and can be surprisingly successful - few people had much optimism when McDonald's and Dunkin' Brands (Nasdaq:DNKN) announced a renewed focus on details like the quality of the coffee they offered.

SEE: Earning Forecasts: A Primer

The Bottom Line
If Wendy's is worth owning, it's on the premise that the company can lift its historically pathetic free cash flow conversion rate to a level more on par with better restaurants like Yum Brands. At this point, even Sonic-level (Nasdaq:SONC) performance would be a nice improvement, let alone getting to par with McDonald's or Chipotle.

Unfortunately, today's price already assumes industry-average level free cash flow production by 2017 and further upside hinges on Wendy's becoming a better-than-average performer. If you believe that's likely, Wendy's may look like a value to you today, but I can't bring myself to share that level of optimism.

SEE: 5 Must-Have Metrics For Value Investors

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

comments powered by Disqus

Trading Center