Wendy’s/Arby’s Group Inc. (WEN), the third largest quick-service restaurant company in the United States, is slated to release its third quarter 2010 results on Friday, November 12, before the market opens. The current Zacks Consensus Estimate for the third quarter is 4 cents, representing an annualized negative growth of 36.7%.

With respect to earnings surprises, Wendy’s/Arby’s has outperformed the Zacks Consensus Estimate thrice and has matched it once in the last trailing four quarters. The average earnings surprise was a positive 84.4%. This implies that the company has beaten the Zacks Consensus Estimate by the same magnitude over the last four quarters.

Last Quarter Recap

During the second quarter 2010, Wendy’s/Arby’s posted adjusted earnings of approximately 7 cents per share, which surpassed the Zacks Consensus Estimate of 5 cents. Including one-time items, Wendy’s/Arby’s posted quarterly net income of $10.7 million, well below $14.9 million recorded in the year-earlier quarter. However, reported earnings of 3 cents per share remained flat year over year.

Total revenue in the quarter under review tumbled 3.8% year over year to $877.0 million and lagged behind the Zacks Consensus Estimate of $888 million. Sales from company-operated restaurants dropped 4.1% to $782.7 million and franchise revenues dipped 2.3% to $94.3 million. Revenues were mainly hurt by sluggish sales at Arby’s restaurants.

Adjusted EBITDA nudged up 3.2% to $120.9 million, attributable to reduced general and administrative expense and a continued expansion in Wendy’s company-operated restaurant profits.

Wendy’s total revenue in the quarter plunged 1.3% year over year to $607.4 million due to the decline in both company-operated restaurants (down 1.2%) as well as franchise revenues (down 1.4%).

Arby’s total revenue in the quarter fell 9.4% year over year to $269.6 million due to lower comparable-store sales. Company-operated restaurants sales declined 9.7% year over year to $250.3 million whereas franchise revenues slipped 5.4% to $19.3 million.

Outlook

For 2010, Wendy’s expects same-store sales at North America company-operated restaurants to be flat, down from its previous expectation to be positive. Arby’s same-store sales are expected to be negative, though improvements are likely on a year-over-year basis.

Moreover, Wendy’s/Arby’s anticipates commodity inflation of 2% to 3% in the second half of 2010.  Thus, a rise in commodity prices will negatively impact the margins of the company. 

Estimate Revision Trend 

Estimates have not changed much in the last 30 days, implying that the analysts do not see any meaningful catalyst for the time being. The current Zacks Consensus Estimate is 13 cents for 2010, reflecting a year-over-year negative growth of 33.3% and 18 cents for 2011, representing a year-over-year growth of 45.1%.

Agreement of Estimate Revisions

In the last 30 days, one out of 15 analysts has trimmed the estimates for both the third and fourth quarter of 2010 and for fiscal 2010 and 2011. None of the analysts has made upward revisions. The one negative revision is based on a weaker sales outlook at each brand due to softer comparable-store sales. Additionally, margins are expected to decline based on higher commodity prices in the second half of 2010.

Magnitude of Estimate Revisions

There has been no change in the last 60 days, in the earnings estimate of 4 cents, 1 cent and 13 cents for the third quarter, fourth quarter and fiscal 2010, respectively, as seen from the magnitude of the Consensus Estimate trend. Therefore, the analysts expect the company to report in line. In the last 60 days, estimates for fiscal 2011 have reduced by a penny to 18 cents.

Our Take

We expect Wendy’s/Arby’s to provide third quarter earnings in line with the Zacks Consensus Estimate.

We believe there are strategic growth opportunities at both Wendy’s and Arby’s brands, including international development under dual-brand restaurants. In our opinion, dual-brand units, combining Wendy’s and Arby’s under one roof, can generate higher sales volumes and a better return on investment.

The company has undertaken a massive remodeling program, and is also investing to improve Wendy’s breakfast line-up and expand Arby’s Value Menu offerings to drive traffic and improve the top line.

Additionally, Wendy’s/Arby’s Group has outlined a multi-year turnaround plan to improve restaurant operating margins, reinvigorate brands, revitalize comparable-store sales and expand internationally. Management believes that there is room for over 8,000 restaurants outside of North America.

While Wendy’s is showing slight improving trends, Arby’s continues to face headwinds with sagging comps and falling margins. Moreover, an uncertain economy with a high unemployment rate and faltering consumer confidence along with steep competition will likely restrain the company’s growth in the near term.

Accordingly, we have a Zacks #3 Rank, (short-term Hold rating). We are also maintaining our long-term Neutral recommendation on the stock.

One of California Pizza Kitchen’s primary competitors, Cheesecake Factory Inc.(CAKE) has reported third quarter 2010 earnings of 37 cents a share, which exceeded the Zacks Consensus Estimate of 34 cents. The better-than-expected results were driven by comparable-store sales growth, higher traffic and effective cost management.

 
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