Wendy's Rides On Refranchising & Reimaging, Costs A Woe

On Sep 12, we issued an updated research report on the world's third-largest quick-service hamburger company The Wendy's Company (NASDAQ:WEN) .

Though the company has solid long-term growth potential but the risks from near-term headwinds might somewhat restrict its growth momentum.

Key Growth Drivers

Notably, the second quarter of 2017 marked the 18th consecutive quarter of positive same-store sales growth for the company, indicating long-term strength and significance of the brand. We expect the company’s solid menu pipeline, limited time offers (LTO), marketing initiatives and increased investments in technology-driven initiatives to maintain the trend, going forward.

Wendy’s remains on track to complete the goal of its global restaurant count reaching 7,500 by the year 2020. Its international business is thus poised to drive growth in the future. In fact, the company has growth plans and partnerships, and long-term development agreements with franchisees in various countries. Also, it is exploring growth opportunities in China, Brazil and other key international markets.

Furthermore, the company boasts a strong pipeline of projects to deliver its 2017 net new restaurant development growth goals of 1% in North America and 14% internationally (up from 12.5% expected previously).

Meanwhile, per the system optimization program, the company has already achieved its goal of reducing company-operated restaurant ownership to approximately 5% of the total system by the end of 2016. Though the reduction in ownership has been weighing on revenues over the past few quarters, we believe franchising a large chunk of its system is expected to lower Wendy’s general and administrative expenses, thereby boost earnings 2017 onwards.

Additionally, Wendy’s remain on track to achieve its Image Activation goals for 2020 as part of the brand transformation initiative. Hereby, the company plans to remodel at least 70% of Wendy's North America restaurants. Reimaging of its restaurants is also anticipated to boost traffic and drive higher sales.

We believe increased investments in technology should quicken service and thus, result in increased customer count. Continual expansion of delivery service also bodes well.

All in all, Wendy’s expects that its balanced marketing approach, new restaurant development and reimaging of restaurants are all key factors that might enable the company to achieve its 2020 target of $12 billion in system-wide sales.

Risks

Higher labor costs due to the implementation of affordable Care Act, commonly known as Obamacare, continue to have an adverse impact on restaurant operators like Darden Restaurants Inc. (NYSE:DRI) , Brinker International Inc. (NYSE:EAT) , Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) and many others, including Wendy’s.

Moreover, Wendy’s would incur additional capital expenditure in the coming years in a bid to boost the re-imaging program. This, in turn, might lead to lower free cash flow in the near term. Also, the Buy and Flip strategy could result in higher interest and depreciation expenses, driven by the new capital leases involved.

The quick-service hamburger company is also experiencing increased commodity costs, primarily for beef and bacon. As a result, the company expects commodity inflation of approximately 3-4% to be an additional headwind for 2017 results. Due to this, Wendy’s has had to move forward with a 1% selective menu price increase in company restaurants. This net effect of higher commodities, offset by the tailwind from pricing, has resulted in a slight decrease in the company’s restaurant margin outlook for the full year.

Meanwhile, a challenging sales environment in the U.S restaurant space is likely to keep the top line under pressure.

Bottom Line

Wendy’s shares have gained 10.4% year to date compared with the industry’s growth of 7%. Furthermore, the company’s earnings surpassed the Zacks Consensus Estimate in seven of the last eight quarters, with the trailing four-quarter average earnings surprise coming in at 6.69%.

Notwithstanding higher costs and capital sending woes, the company’s refranchising and reimaging initiatives are anticipated to continue driving growth over the long term.

Wendy’s currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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