WEN - The Wendy's Company: Remaining Neutral Until More Evidence Of Sustainable Turnaround Trends

2023-07-01 23:41:39 ET

Summary

• I maintain a hold rating on The Wendy's Company, believing that its stock price movement is influenced by comparable sales growth, expansion into other meal segments, and unit growth.
• Despite the positive SSS growth, I am cautious about Wendy's expansion into other meal segments, especially breakfast, due to strong competition.
• I warn that the current macroeconomic situation, including high inflation and rates, could pose long-term challenges.

Thesis

Recapping my previous update on The Wendy’s Company ( WEN ), I believed that the stock price movement is determined by two factors: the growth in comparable sales, and the company's success in expanding its customer base to include other types of meals served throughout the day (aside breakfast). Additionally, if unit growth exceeded expectations, the stock price would also reach positive as well, as I believe investors are not pricing in a lot of unit growth at this point. My overall thesis has not changed, but am getting more positive as WEN continue to execute on improving SSS. I reiterate my hold rating as I still think the best time to invest is when WEN has successfully executed on all 3 aspects that I called out previously (SSS, penetration to other types of meals, unit growth).

SSS improvement on track

Each month of the quarter saw moderately positive traffic growth for SSS, bringing the quarterly total to 7.2%. The more important focus is the strategy that resulted in this 7.2% is proven right and is working, especially the expansion of digital sales—which now account for more than 11% of the company's total revenue in the United States. The latter is an interesting point to note as I believe there is still room for this to go up further given the nature of food that WEN is serving. To give comparison, Wingstop (WING), another QSR player, has a much larger mix of sales driven by digital channels. I expect management to spend more effort on gaining more presence in the digital channels as it could further increase store level utilization during non-peak periods, which will drive overall SSS. Since WEN has already shown success in international markets with a digital mix of 19%, expanding in those areas shouldn't pose any problems. Apart from that, it is encouraging to see that WEN has been able to increase prices with little indication of a trade-down or resistance. As it stands, pricing will now run ~7% for the year, which I expect to continue supporting SS for the rest of the year.

Penetration to other meals

As the world starts to return back to normalcy, I believe it will be easier for WEN to establish their strategies to penetrate other meals during the day. For instance, management will be able to base on historical demand trends to firm up a strategy to target the late-night or day-part meals segment. That said, I still prefer to keep my fingers crossed on this, without putting too much expectations yet as the competition for breakfast is extremely tough. Unlike late-night meals (typically QSRs), breakfast competitors come from guys like Starbucks ( SBUX ) and Tim Hortons as well (coffee is an important part of breakfast). As such, menu innovation is important here to distinct itself from the pack – tough to do due diligence on this before the menu is out, hence, my view to not put too much expectations yet. Of course, promotions and bundling can work too, but they are not sustainable if they do not translate to long-term recurring customers.

Stores development

WEN store development efforts seem to be lacking as there were no net new openings, but I would remind that this was within management expectations (which is largely due to timing). I would also expect 2Q23 to see rather muted growth given the commentary that store closures will be front loaded while development is back half loaded. On a sequential basis, we should see growth acceleration in 2H23 and further acceleration in 1Q24 when the new stores mature. Management remains upbeat about achieving the 2-3% net unit growth target for FY23, given that ~45% of the expected units are already open or under construction. That said, I would warn that the current macro situation (high inflation and rates) does not bode well from a long-term perspective. If it persists for longer, it would result in more pain eventually.

Conclusion

My thesis on WEN remains unchanged in that I believe WEN stock's price movement is influenced by comparable sales growth, expansion into other meal segments, and unit growth. So far, WEN has shown positive results with a 7.2% increase in SSS and a growing digital sales mix. I believe expanding further in digital channels can drive overall SSS and store utilization. However, penetrating other meal segments, especially breakfast, poses challenges due to strong competition. Menu innovation and sustainable strategies are crucial. As for store development, management remains confident that they can accelerate developments in 2H23, supporting the target of 2-3% net unit growth for the year. Overall, I maintain a hold rating and suggest investing once WEN achieves success in all three aspects mentioned.

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