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Estimating The Fair Value Of The Wendy's Company (NASDAQ:WEN)

Key Insights

  • Wendy's' estimated fair value is US$20.31 based on 2 Stage Free Cash Flow to Equity

  • With US$23.50 share price, Wendy's appears to be trading close to its estimated fair value

  • Our fair value estimate is 19% lower than Wendy's' analyst price target of US$25.22

In this article we are going to estimate the intrinsic value of The Wendy's Company (NASDAQ:WEN) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Check out our latest analysis for Wendy's

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$269.3m

US$318.6m

US$346.7m

US$389.0m

US$409.0m

US$424.8m

US$439.0m

US$452.0m

US$464.3m

US$476.0m

Growth Rate Estimate Source

Analyst x7

Analyst x7

Analyst x2

Analyst x1

Analyst x1

Est @ 3.86%

Est @ 3.34%

Est @ 2.97%

Est @ 2.71%

Est @ 2.53%

Present Value ($, Millions) Discounted @ 11%

US$243

US$260

US$255

US$258

US$245

US$230

US$215

US$199

US$185

US$171

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 11%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$476m× (1 + 2.1%) ÷ (11%– 2.1%) = US$5.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.6b÷ ( 1 + 11%)10= US$2.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$4.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$23.5, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Wendy's as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 1.458. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Wendy's

Strength

  • No major strengths identified for WEN.

Weakness

  • Earnings declined over the past year.

  • Interest payments on debt are not well covered.

  • Dividend is low compared to the top 25% of dividend payers in the Hospitality market.

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by cash flow.

  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Wendy's, we've compiled three essential elements you should look at:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Wendy's (at least 1 which makes us a bit uncomfortable) , and understanding these should be part of your investment process.

  2. Future Earnings: How does WEN's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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