WEN - Wendy's Is A Good Buy At Current Levels

2023-11-29 16:32:47 ET

Summary

• Wendy's revenue growth is expected to benefit from price increases, promotional offerings, and strength in breakfast and late-night dayparts.
• The company plans to implement further price increases, but at a smaller scale, to ease pressure on price-sensitive consumers and gradually recover traffic count.
• Wendy's is focused on expanding its scale through new unit development, both domestically and internationally, to sustain long-term sales growth.

Investment Thesis

The Wendy's Company ( WEN ) has good growth prospects ahead. The company’s revenue growth should benefit from the carryover impact of previous price increases and incremental pricing actions planned by management in the coming quarters. In addition, increasing promotional and value offerings, and good strength in the breakfast and late-night dayparts, should also benefit the company's sales growth. In the long term, accelerating net new unit development, especially internationally, should help the company’s sales growth. While there are concerns regarding declining consumer traffic in an inflationary environment, I believe the above-mentioned tailwinds should help the company gradually recover traffic count, and sustain its sales growth in the coming year.

On the margin front, the company should see benefits from pricing increases, moderating inflation, productivity gains, and improving business mix. The company’s good growth prospects, combined with a lower-than-historical valuation and a good dividend yield make the stock a buy.

Revenue Analysis and Outlook

In my previous article on Wendy’s, I discussed the growth prospects for the company moving forward, benefiting from price increases, growing breakfast and late-night dayparts , promotional offerings and footprint expansion. The company reported earnings for its third quarter of 2023 since then and similar dynamics were seen.

In the third quarter of 2023, Wendy’s revenue growth benefited from higher average checks driven by price increases, and good demand during breakfast and late-night dayparts. In addition, new restaurant development both domestically and internationally also boosted the revenue growth in the quarter. However, these benefits were partially offset by a decline in customer count as price-sensitive consumers shifted to food at home in an inflationary environment. Overall, revenue in the quarter grew by 3.4% to $551 million. On a same-restaurant sales ((SRS)) basis, revenue increased by 2.8% YoY, reflecting a 2.2% YoY SRS growth in the U.S. and 7.8% YoY SRS growth internationally.

Looking forward, while there are concerns regarding the declining traffic count given the persistent economic uncertainty and inflationary environment, I believe the company should be able to sustain its top-line moving forward, benefiting from price increases, value, and promotional offerings, growth of breakfast and late-night dayparts , and new unit expansion.

Similar to other players in the industry, Wendy's implemented price hikes to counter inflationary challenges, positively impacting the company's same-restaurant sales. In May, the company introduced its last round of pricing adjustments and intends to implement further increases in menu prices towards the end of the fourth quarter or the beginning of the next year. The combined effect of these additional price increases and the carryover impact of previous price adjustments should help sustain the growth of the company's same-restaurant sales.

While the company plans to make additional price increases, management expects further price increases to be much smaller as compared to those made already. This should take some pressure off price-sensitive consumers and also give room for guest traffic to gradually recover with moderating inflation. Moreover, as I mentioned in my previous article, the company has been continuously offering value offerings and promotions to attract price-sensitive consumers. This has helped the company in partially offsetting traffic decline. For instance, in the third quarter, the company launched BOGO (Buy One Get One) for $1 promotion and a new value offering, 2 for $3 Biggie Bundles, which according to management, helped drive sales in the back half of the quarter. Moving ahead, the company plans to continue on these promotional offerings, and I believe this should drive traffic for the company as consumers get out more to enjoy food services during the upcoming festive and holiday season this winter.

Promotional and value offerings along with more moderate price increases should help the company gradually recover traffic count over the next year. Furthermore, I believe the company should also benefit from good demand in breakfast and late-night dayparts . After the pandemic, as consumer mobility increased, promotional and value offerings and consistent menu innovations attracted consumers to Wendy’s restaurants during the breakfast daypart. This has been supporting the company’s overall sales over the past few quarters. The company plans to continue innovating new menu launches and promotional trials to further drive the breakfast daypart, as it continues to expand in new markets.

In addition, the late-night daypart is also experiencing positive effects from the increasing customer preferences toward late-night snacking, further boosted by the company's value-based promotions. In the third quarter, late-night daypart sales increased by mid-teens year-over-year and also surpassed the pre-pandemic average. These dayparts should continue to bring incremental traffic to Wendy’s restaurants as consumers continue to discover value-based offerings across dayparts.

Lastly, for long-term sales growth, expanding scale through new unit development is the heart of any company within the food service industry. Wendy’s has been fully focused on this area over the current year. While new unit development is a little slow this year due to permitting delays, the company is all set to accelerate new restaurant development in 2024.

Recently, Wendy's expanded its market presence in the United Kingdom by adding a new franchisee, while three existing traditional franchisees have expanded their development commitments. In Japan, an existing franchisee has accelerated their store opening agreement as operations return to normal post-pandemic, with improving sales. Additionally, the company has witnessed a substantial rise in agreements within the United States and Canada across its suite of development programs. These positive developments complement the previously announced master franchise agreement with Flynn Restaurant Group to establish 200 Wendy's restaurants in Australia, extending the company's development plans beyond 2025. These openings are in line with the company’s long-term goals of opening 2% to 3% net new restaurants in 2024, and 3% to 4% net new units in 2025, with 70% of the growth coming from international expansion. Hence, I remain optimistic that the company should be able to sustain its topline amid uncertain economic conditions. I anticipate a gradual recovery in guest traffic in the upcoming quarters as inflation eases and the effectiveness of the company's value and promotional initiatives persists.

Margin Analysis and Outlook

In the third quarter, the company’s margin growth benefited from price increases and productivity gains. This helped the company in more than offsetting inflationary labor and commodity costs, which were a headwind of ~4% and ~2%, respectively. This resulted in a 70 bps YoY increase in global company-owned restaurant-level margin to 15%, while the adjusted EBITDA margin stayed flat at 25.3%. The Adjusted EBITDA was impacted by the lapping of a significant gain from insurance recoveries in the prior year quarter.

Looking forward, I believe that the company should be able to deliver margin growth. Inflationary commodity and labor costs which have been pressuring the company’s margins for the last several quarters have already started moderating. In the first quarter, the company incurred commodity and labor wage inflation of 7% and 5% YoY respectively, which moderated to 2% and 4% YoY in the second quarter and the third quarter. I believe inflation will continue to moderate moving forward. Moreover, Y/Y inflationary comps should also become favorable as we move into 2024 supporting the margin growth for the company. This should be further aided by the carryover impact of previous price increases and additional pricing planned for the coming quarters.

In addition, the company’s mix of business is also becoming favorable. The company’s breakfast and late-night dayparts are its higher margin dayparts and as discussed in the revenue analysis, growing revenue in these dayparts should improve the mix, lift up sales leverage, and help in margin growth. Moreover, the company is also seeing staffing and labor turnover improve across all dayparts, which is helping the company properly staff its restaurants all the way from breakfast through the late-night daypart. This has been increasing productivity and should continue to help the company’s margin moving forward. Hence, I remain optimistic about the company’s margin growth prospects ahead.

Valuation and Conclusion

Wendy’s is currently trading at a 16.99 FWD P/E based on the FY24 consensus EPS estimate of $1.11, which is below its historical 5-year average FWD P/E of 29.44x. I believe the valuation remains attractive given the good growth prospects ahead. Benefits from price increases, promotional and value offerings, strength in breakfast and late-night dayparts, and moderating inflation should all contribute to revenue and margin growth for the company moving forward. Moreover, a compelling forward dividend yield of 5.29% is also an added benefit to investing in Wendy’s. Hence, I continue to have a buy rating on the stock.

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