Chit Chat Stocks - Fundamental Analysis: Wendy's (WEN)

Episode Date: April 16, 2020

On this show we discuss Wendy's. Find out why Brett gave it a rating of 5.3 and Ryan a rating of 4.8 --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome in. You are listening to the Fundamental Analysis Show on Chit Chat Money. My name is Brett Schaefer and I'm here with Ryan Henderson. And today we're going to be talking about a well-known name, a fast food company, Wendy's, a publicly traded company. So, Ryan, do you want to get into what they do and then the history of the company? This is something, you know, we got a recommendation to do this, I think, or maybe it was not this in general, but people are complaining, you know, oh, you're doing too many high-growth tech names.

And we're like, well, maybe. But this will mix it up a little bit, I think. Yeah, and maybe we'll realize why it's less fun to do these because it seems like there's a little less avenues for growth. But sometimes you can find good value in these. So it should be fun to look at this one. Wendy's is an international fast food restaurant chain. Most people know that.

They do franchise out most of their stores and they collect money through rent and franchising fees from those store owners, but they also have a fair amount of company-owned stores as well. So they have a few that they operate that are not franchised out. They are well-known, though, for their square hamburgers and their Frosties. That's what most people know them for. And the Wendy's company determines the standards for each store's exterior appearance, food quality, and menu, but the store owners have control over the hours of operation,

interior decor pricing staff uniforms and wages so there's sort of a balance there between uh what the what corporate gets to determine and what the actual store owners or the restaurant operators get to determine themselves um some history for wendy's wendy's style of burgers and frosties were inspired by dave thomas's trips to cupi hamburgers in kalamazoo michigan so uh this cupi hamburgers was known for their square hamburgers and thick malt shakes so i guess dave thomas just decided i'm just going to copy that and franchise it out um so he founded wendy's in 1969 in columbus ohio and dave thomas named the first store after his fourth child melinda lou wendy thomas which is the most american name i've ever heard yeah

definitely the first franchise was started in 1972 i think that was in indianapolis and the rest is history after that they've obviously expanded store count um they are now the third largest burger fast food chain behind only burger king and mcdonald's it looks like they ipo'd in 1992 but it was a little difficult to tell because there was sort of a spinoff at one point and even a merger so there was like different equity raises i'm i'm pretty sure but it looks like the first ipo was in 1992 yeah with the restaurants i mean the chains and stuff when they're publicly traded they always go in and out private to public and then they're always like scooping up competitors and things like that there's a lot of moving parts in that

but I'll get it to the financials here. Uh, they have a market cap of $3.85 billion ticker of W E N and a price of $16 and 74 cents as of April 15th, 2020 tax day. Actually, we're recording this, uh,

comes out the day after. Well, no typical tax day, typical tax day. Yeah. R I P uh, their P E is 27.9. So about 28 and you,

for reference, their Evie is about double of what their market cap is right now because of Their long-term debt is at about $2 billion. Their price to sales is 2.25. And again, their EV to sales is 4.2. EV to free cash flow is 33.65. So pretty, you know, they're not, even with the drop-off here, they're not valued very cheaply.

I guess that's what a lot of the premium restaurants like McDonald's isn't valued that cheaply usually. Starbucks, you know, it's a little different. But they have a dividend yield of 1.89%. shares outstanding have actually gone down a lot. Since 2010, they've gotten cut almost in half. So good capital allocation there. Stock went down over 50% in the past month from $24 to 750. That's about 60 or 70%, I think. And that was from the end of February to middle of March. So less than a month. Now it's back up to 1675. So it's recovered a bit. Their ROIC, which is the return

on invested capital has been quite low never been above seven percent but it hasn't really been negative they've been steadily having you know small uh roic numbers and they have small working capital and a lot of long-term debt so not the best balance sheet but nothing where it doesn't look like an airline or anything right um i'll get right into the earnings then i didn't put much from the balance sheet on here so uh maybe you can refresh them after i talk about the earnings on the debt side. Total revenues for 2019 grew to $1.7 billion, up 7.5% year over year. Company-operated restaurant margin was 15.5% in 2019, and that was basically flat from 2018. Net income was down 70.2% versus the year prior. That was due to their sale of

Inspire Brands. I believe EBITDA was basically flat, and EBITDA was actually a relevant metric. So net income for 2018 was $460 million. I remember EBITDA, I don't have it down here exactly, but I remember EBITDA was actually an adjustment down. So it was like $420 million or something like that. And that was basically flat year over year. So profitability, as far as operating-wise, hasn't been hindered that much. In 2018, they had a net margin of 27%.

Their fourth quarter net income this year was up 41% year over year. That was due to a cash settlement of a previously held investment. and then the free cash flow was down 4.5% year over year, they have free cash flow margins right around 13%. Welcome back. Next, we have the second half of the show. And first up is, as always, Digging Trenches, which is just the moat rating.

What do you think, Brian? So it's hard to... There are capital-intensive barriers to entry in terms of scaling a large franchisee business like Wendy's has done. So it's hard to kind of just start one up like that. However, it's a super crowded space. They are the third largest burger fast food chain,

but they also have to, I mean, they're not just competing with burgers, they're competing with all food stores. So even Chick-fil-A, even some of those more expensive ones are going to come into play as well as far as competitors. They also have to – yeah, there's burgers, but there's burritos. So Chipotle, Taco Bell, Taco Time, stuff like that. Anyway, it's food, so it's super crowded.

But like I said, they've established themselves well, and it's taken a long time to do so. So I'm going to go with a 1.5. I give it more of a 2 because I think it is hard. it is pretty hard to get into the restaurant chain business to start up you know it takes a lot of capital to expand uh it's definitely not a reason you know it might be a reason you would invest in wendy's or a fast food business but it's it's not as strong as some other types of business i mean mcdonald's is probably the number one uh for a moat but it's still not crazy uh

yeah i guess it is a little it's really strong with mcdonald's but for wendy's it's like and it's it's pretty good they do have a relatively strong brand as well i mean you recognize the logo when you see it so um yeah i guess two is probably fair for him what are you looking at for further reading so further reading this is what i'd want to research uh i would look at more market research on the breakfast opportunities i know a lot of fast food places are trying to dive into breakfast uh who does that who's the main one that mcdonald's is the main one i guess um as well as uh does it as well and they do well with it um but mcdonald's is kind of you know whenever someone starts a new uh breakfast menu people are always saying oh they're encroaching

on mcdonald's territory yeah yeah so i guess mcdonald's would be that but yeah wendy's getting to that um if they could come up with something innovative i don't know you they actually just came out with it so it looks like you're going to talk about that in the future growth opportunities I mean, if there's a giant market there, maybe that could help them sustain solid same-store sales growth for the next few years here. And yeah, I'd really want to know what that is. Their product offerings are relatively limited for breakfast anyway, so there are definitely opportunities out there besides what they offer now. But I'm looking at net store count post-coronavirus here. So Wendy's announced that they're extending the date for restaurant operators to pay their fees and rent due to major declines in sales.

So store count should be a clear indicator of franchisees' inability to pay over that time. Because, I mean, if you can't pay rent to Wendy's, then you're not going to be able to operate your business. It's going to go under, and you're going to see that in the store count. And obviously, net is the one to pay attention to there. Yeah, because they need their franchisees to stay around because they would have to spend a lot more CapEx if some of those went under and then to get new managers, someone to invest in a store, things like that. Yeah, definitely want to be watching that number. And with that extension involved, we might not see the fruits of this come out until two quarters or three quarters from now in terms of net store count just because people maybe try to take on a loan to pay that off. And then there's also, you know, maybe the extension goes on for another three months.

And Wendy's obviously wants the best for their franchisees because it in turn gives them enough money. So it might be a while until we see that materialize. Yeah, definitely. All right. Future growth opportunities are next. And it looks like you have breakfast. So do you want to get into that? Yeah. So Wendy's Nationwide Breakfast was launched on March 2nd. They currently offer five breakfast items. They have the Breakfast Baconator, the Honey Butter Chicken Biscuit, the Maple Bacon Chicken Croissant, the Vanilla Frosty Chino, and Seasoned Potatoes.

Frosty Chino. Whoever's going to know it. That sounded better than the Seasoned Potatoes for breakfast. But the Frosty Chino, it was basically like it looked like coffee, iced coffee, and then you add a vanilla frosty or a chocolate frosty creamer, I think is what they said. So it didn't look that bad. It's not like they're mixing it with a Frosty, like a real one. Poor timing on the launch.

Just a little unlucky there. Yeah, really unlucky timing there. On their conference call, though, they also stated that they invested $17 million to support the launch of the breakfast. So put a lot of money into it. They're going to have to hope that benefits them in the long term. This year was sort of a big CapEx year. I remember them saying they spent $5 million on something else. I think it was digital. I'm blanking on the word, but probably just the app or something. I don't

know. So something around like digital offerings, pickup, stuff like that. Delivery card receivers. Sorry. Oh, card receivers. Okay. Yeah. They enhanced a lot of those for some of their stores. And so they included that in CapEx. I think that was 5 million altogether with that. And then 22 million combined with the breakfast. So lots of CapEx there. But some of those offerings, I mean, I'm not a big fast food person, but I could see how Wendy's customers would enjoy that for breakfast as well um so yeah i'm not a big wendy's guy but some of those sounded interesting maybe i'll try the vanilla frosty chino yeah the it seems different than mcdonald's at least so you know they're trying to just differentiate themselves but i'll get into

mine here uh the other two pillars that they talk about for their growth strategies are digital and international digital is easy um if you're a fan of chipotle stock you probably know how they do that, the digital sales through the app, through all the delivery places, trying to get customers to order that way, make it super easy. I mean, it's another way. I mean, yeah, it's a little lower margin, but they don't give out very many numbers on the digital. So I'd like to see what kind of growth they're getting in there. It'd be nice if it was like 25, 30% growth. And then their other one is international. They opened 77 total stores in 2019 and only 21 were international. So they say that international is their growth lever, but I would like to know how much potential they think they have, because I know America, the United States is the number one fast food nation are, you know, can they expand to China, Southeast Asia, Europe?

Is there enough demand out there for them? Also, like, OK, Wendy's seems like an American fast food restaurant, you know, just with the logo and the girl with the red hair and all that stuff. But I wonder if like in India, the Middle East, Australia, countries or continents that are outside of North America, do they like, oh, you guys want to have American tonight? Like, is that a thing? Yeah, that's probably it. Because, I mean, McDonald's, I guess, has gone global. So maybe there is a lot of demand for a burger place and Burger King is pretty global as well. But I think they do change up the menu slightly.

But yeah, I was in. Well, their burgers are square. so yeah that is different i was in spain this winter and they're huge five guys fans so i think they do like the american food and they think of it like it's the burger is the like the american thing you know how like there's more than just tacos and burritos uh for you know mexican and south american food but yeah they think people in other countries they think burgers and fries yeah makes sense uh highlights and lowlights what do you like there okay highlights for me it's a very stable business uh i mean you can't doubt the american eater they're just gonna keep going

uh there's room for stay-in-store sales growth because they're you know they can encroach a little more on mcdonald's and burger king um they have a strong capital allocation history so the stock is basically gone except for the last you know month here up into the right and they also had a nice share buyback program so it showed that the share buybacks have helped you know with their earnings per share and they would have it would have been a phenomenal buy the dip the last uh like if you look at the chart i'd recommend looking it up it was down so quickly and it recovered just like that like it was amazing to see that but low lights for me fast food seems like it's pretty uh saturated uh no pun intended uh like there's not that much room for growth you

know it's they're everywhere like there's not in every small town in america or not like tiny towns but it seems like there's not that much room for growth for fast food in general they're gonna have to encroach on mcdonald's and burger king and others and they also have a lot of debt compared to their free cash flow they're gonna have to grow the free cash flow a lot uh to get that number where they're not just paying it down with all their uh cash they're generating right um My highlight here is the business model just isn't all that complicated. All they have to do is drive same-store sales growth and have stable net restaurant expansion.

And if they're able to do that, they're going to be just fine. Also, I'm thinking about this now. Are fast food restaurants sort of recession resilient? If we went into a recession or something, okay. So maybe that'll be a highlight here because Chipotle was doing well. maybe those more expensive ones will start to suffer a little bit if we yeah because what you can get i don't know i haven't uh you know not to to brag i don't really go to the fast food places but they're like you can get some for like three four or five bucks but like chipotle or something

you might be closer to 10 right right um but my low light is that it is a super competitive market and i guess there may i mean the trend of health i know that was kind of more of a maybe a 2019 kick with the whole no meat thing. But maybe that's still going on. They aren't doing well with that, I would say. They're not the picture of health. But my other problem here is the competition. So not only do they compete with other burger places, but with the ubiquity of food delivery nowadays, they're competing with everyone. And that makes it hard for me to invest in a lot of food companies because anything can get delivered now so it's you know and i know a lot of people go through like fast food restaurants on the way home from work or something like that

but if you're home you're thinking i want fast food you can literally go anywhere where or you can have it delivered to you so i i think the competition grows larger with the ubiquity of that um and the margins are going to decrease because you have to pay uh you know delivery costs more and it's a lot easier to compete with someone when you can you know on the internet everyone can just pay for space but if you have those uh stores that's kind of an advantage you have where no one can just pop up a store really quick exactly what's your what's your rating for the stock it's not going to be that high uh the balance sheet is definitely not strong enough where i can think say someone like you know starbucks they have some debt as well but the

reason i used to own them is because i thought they could have great dividend and great share buybacks with a large market opportunity. I do think Wendy's can expand if they have the right management team in place, the right marketing. They do like the chicken nugget stuff that seems to be popular and like the chicken sandwich seems pretty popular as well. But the debt levels are high. The free cash flow hasn't really been there. The growth hasn't been that great compared to a lot of other brands and the valuation is high their ev to sales is 4.2 and if you take into account an operating margin for a restaurant of about 15 that would give them an ev to uh earnings or cash flow if you think that whatever the operating margin and cash flow is similar

of about uh like 30 which is quite high still um and i just can't get around that yeah oh so sorry sorry i give it like a five three okay yeah i think maybe i have a problem judging a lot of these slower growth uh compounders you know i mean what you're gonna get here is seven percent revenue growth you're gonna combine that with same store sales and restaurant expansion and that just that just sort of bores me but maybe that's what provides the best returns over time so if you're we don't have any sort of expertise in the like food industry. And you're not getting a whole lot of exciting growth there. There's not any massive changes to business models and in terms of restaurants. It's not horrible. Like it's not

an insane valuation. I think it would have been a good value play under $10. And if it gets back down to those levels, maybe it will be, you just have to pay attention to liquidity and the debt levels there um but this does not crack my top 10 and especially when stocks are not at all-time highs you really you really got to get picky with the ones you like um and kind of for me i take i try to take concentrated positions especially when there's a lot of stock selling off and so this just does not crack my top list i'm gonna go 4.8 maybe well yeah yeah i mean with restaurants uh i i just think with something like this it's not going to grow that quickly i cannot pay up for something like this i would wait this has to become a value play i'm not paying for an earnings

multiple over 20 um and that's just me uh for a stock like this right all right well that's going to do it for this episode again thank you guys for listening make sure to follow us on twitter at chit chat money and if you have any suggestions uh i don't think we tweeted out but we did change the podcast email uh that we just started uh do you want to say what that is for anyone that has questions or suggestions chit chat money podcast at gmail.com yeah and we'll tweet it out uh and then yeah so if you have any suggestions that's another way for you guys to reach us because i know someone was asking about that remember we are not financial advisors anything we say on this show is not formal advice or recommendation thank you guys for listening we'll see you next time

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