Wendy's Banks on Unit Expansion & Technology Amid High Costs

The Wendy's Company WEN is consistently relying on menu innovation, technological upgrades, international expansion and re-imaging of units to drive top-line growth. The company is also benefiting from its transition to a franchised business model. However, rising expenses and fickle consumer demand continue to hurt Wendy's.

In the third quarter of 2019, the company’s top line gained from increased franchise royalty revenues and fees driven by restaurant development and lower franchise incentives. On the bottom-line front, Wendy’s outpaced the Zacks Consensus Estimate in the same quarter. In in three of the trailing four quarters, the company’s delivered a positive earnings surprise of 14%.

As a result, shares of Wendy’s have gained 38.1% so far this year compared with the industry’s 19.2% rally.

Key Catalysts

Wendy’s sincerely focuses on expansion initiatives to fortify brand presence and drive revenues. The company expects global net new unit growth to be 1.5% in 2019. Notably, its international business is thus poised to be a major growth driver in the future. It also has growth plans and partnerships in Argentina, the Philippines and Japan.

Additionally, the company is exploring growth opportunities in China, Brazil and other key international markets. Wendy’s also announced that it will enter Europe by opening restaurants in the UK. Notably, the company anticipates the count to increase to 1500 restaurants internationally and double its sales to approximately $2 billion by 2024.

With the advancement of Image Activation, Wendy’s is progressing well with its unit development goals. Last year, the company opened 159 restaurants as part of its expansion endeavors. This suggests roughly 1.2% global net new restaurant growth in 2018. During the third quarter, the company reported 40 global restaurant openings, with an increase of 24 net new units.

Furthermore, Wendy’s consistent efforts to improve its franchise relations are supporting expansion. It plans to continue facilitating franchisee-to-franchisee restaurant transfers through its buy-and-flip strategy. This strategy ensures that restaurants are put in the hands of well-capitalized franchisees, committed to long-term growth. In 2018, Wendy’s facilitated 96 Franchise Flips. In 2019, the company expects to complete 100-200 Franchise Flips.

The company’s brand transformation initiative comprising menu innovation, promotional offers and bold new packaging intended for boosting sales is an added positive. We expect solid menu pipeline, limited time offers (LTO), marketing initiatives, and increased emphasis on core and price value offerings to help maintain the trend.  By virtue of such initiatives, Wendy’s remain on track to achieve its 2020 target of $12 billion in system-wide sales.

Concerns

In order to compensate for high labor costs, Wendy’s is taking strategic initiatives to realign and reinvest resources. Although these initiatives might benefit the company over the long term, these are expected to increase costs in the near term and hurt margins.The company might also have to focus on cost savings and increasing same-restaurant sales to cope up with these inflations.

In a bid to boost the re-imaging program, Wendy’s is likely to incur additional capital expenditure in the coming years. This might lower free cash flow in the near term. Though the company has transitioned toward a franchise-based model that downscales capital expenditure, it will take time to reap benefits. For 2019, the company expects capital expenditure of approximately $75-$80 million.

Zacks Rank & Stocks to Consider

Wendy’s currently carries a Zacks Rank #3 (Hold). A few better-ranked stocks in the restaurant space are Chuy's Holdings, Inc. CHUY, Chipotle Mexican Grill, Inc. CMG and Dunkin' Brands Group, Inc. DNKN. While Chuy’s sports a Zacks Rank #1 (Strong Buy), Chipotle and Dunkin carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Chuy’s, Chipotle and Dunkin long-term earnings are estimated to witness 17.5%, 19.7% and 10.9% growth, respectively.

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