We are maintaining our Neutral recommendation on Wendy’s/Arby’s Group Inc. (WEN).
High commodity costs, heightened competition and faltering consumer confidence compel us to retain our guarded view on company-operated restaurant margins, despite the company’s multi-year turnaround plan.
Wendy’s/Arby’s Group posted first quarter 2011 adjusted earnings of approximately a penny per share, which narrowly missed the Zacks Consensus Estimate. On a GAAP basis, the Atlanta-based company’s loss narrowed to $1.4 million or a break-even point per share, compared with a loss of $3.4 million or one cent per share in the prior-year quarter.
Wendy’s/Arby’s Group is investing to improve Wendy’s breakfast line-up, while driving traffic and improving sales. Breakfast is critical to the company’s growth strategy. Since 2005, the company’s QSR breakfast traffic has grown 13%, while the industry has grown only 2%.
In 2010, the company introduced its new breakfast line in four markets, namely Pittsburgh, Kansas City, Phoenix and Freeport. Over the remainder of this year, the company will continue to add more breakfast markets. Some of the new offerings of Wendy’s include Berry Almond Chicken Salad and Fresh Berry Frosty. A new line of cheeseburgers is also in the offing this year.
Wendy’s/Arby’s Group has also undertaken a massive remodeling program. For 2011, the company plans 100 store remodels. We believe it will be beneficial for the company to focus on remodeling restaurants as most of its peers have embarked on a remodeling plan. 2011 is a transitional year for the company. It is selling the Arby’s restaurants so that it can focus solely on building the Wendy’s brand.
Wendy’s/Arby’s Group is also strengthening its geographical footprint. Wendy’s recently announced its growth plans and partnerships in Argentina, the Philippines and Japan. Furthermore, Wendy’s has a long-term development agreement with franchisees in the Middle East, North Africa, Singapore, Turkey, Russia and the Eastern Caribbean.
However, we are compelled to remain on the sidelines with Wendy’s/Arby’s Group, considering the sluggish economic recovery, stiff competition and steep rise in commodity costs specially beef.
Following the first quarter 2011 earnings release, the company anticipates inflation of 5% to 6% in commodity costs versus 2% to 3% during 2011. Beef represents almost 20% of the total food cost. The company uses fresh ground beef, which is expected to be at historically high levels in the second and third quarters of 2011.
On a year-over-year basis, the cost of meat is expected to rise about 20%. Thus, the company anticipates Wendy’s company-operated restaurant margin to be flat to slightly negative in 2011 compared with its previous outlook of an improvement of 30 to 60 basis points.
In the first quarter, the company witnessed soft business in Canada on the back of an increased sales tax, which led to a rise in menu prices in a couple of provinces. According to management, the Canadian market is already much higher priced than the U.S. Thus, the price increase left a much deeper impact on Canadian consumers that caused same-store sales to decline by 4.7%. We do not expect significant improvements to this situation in the near future.
Moreover, although the company signed franchise development agreements for international growth, the scale for peers McDonald’s Corp. (MCD) and Yum! Brands Inc. (YUM) are much larger. The larger scale advantage provides the peers of Wendy’s/Arby’s Group with greater advertising strength and the ability to allay the rising cost pressure. Wendy’s/Arby’s Group currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.
MCDONALDS CORP (MCD): Free Stock Analysis Report
WENDYS/ARBYS GP (WEN): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis Report
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