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Wendy's Shares Worth $5 Given Improving Fundamentals

 November 09, 2012 04:19 PM


(By Mani) Shares of The Wendy's Co. (NASDAQ: WEN) are worth $5 based on 8.5 times its 2013 estimated EV/EBITDA ratio, which is roughly in line with its peers given its long-term potential for improved sales and profits as well as international expansion. Currently, shares are hovering around $4.

Wendy's is the world's third-largest quick-service hamburger company. The Wendy's system includes more than 6,500 franchise and Company restaurants in the United States and 27 countries and U.S. territories worldwide.

The same store sales of Wendy's, which doubled its quarterly cash dividend to 4 cents per share and authorized a new share repurchase program of up to $100 million through Dec. 29, 2013, are improving and its recently raised dividend represents a yield of 3.6 percent puts a floor under the shares. That said, meaningful earnings improvement rests on the pacing of its remodel program.

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The company has been gradually refurbishing restaurants and modernizing menus in an effort to keep up with larger rivals McDonald's (NYSE: MCD) and Burger King Worldwide, Inc. (NYSE: BKW) under its image activation program.

Wendy's said it has seen improved performance by more than 25 percent at stores that have had a make-over in 2011, and that it is on track to reimage about 48 existing company-operated restaurants in 2012. The company added that it remains on track to reimage 50 percent of company-operated restaurants by the end of 2015.

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"The pace and subsequent sales and earnings lift from reimaging isn't large enough to warrant a multiple higher than its current 8x EV/EBITDA, in our view," RBC Capital Markets analyst Larry Miller said in a client note.

The roughly 265 stores planned for 2013 amounts to 4 percent of the store base and equates to a 1 percent lift if all these stores generate 25 percent same store sales lifts.

"The actual gain will be lower given the remodels will occur throughout the year; the stores need to be closed for about two months, and the remodels will be a mix of Tier 1-3 remodels, which generate gains from 7%-25%+.," Miller noted.

The program will accelerate if Wendy's reaches its 50 percent of the company base (750) target by 2015. However, the sales lift will still be a modest 1 to 1.5 percent a year.

"We'd become more interested in the shares if the reimage program were accelerated, and thus the sales and EPS lift larger," the analyst said.

However, this seems unlikely at this juncture as zoning, construction, people and training limits the remodeling rate according to management. Wendy's has the capital to complete its 50 percent target that could $500 million. These would not be spent from free cash, but from its over $450 million in cash on the balance sheet.

Dublin, Ohio-based company reported a net loss of $26.16 million or 7 cents per share for the third quarter, wider than $3.97 million or 1 cent per share in the prior-year quarter. Excluding it earned 3 cents 3 cents per share, lower than Street view of 5 cents per share.

Consolidated revenues for the quarter grew 4.1 percent to $636.31 million, but missed sixteen Wall Street analysts' consensus estimate of $640.17 million.

Wendy's company-operated restaurant margin improved 20 basis points to 13.9 percent on improved same store sales, partially offset by costs related to investments in customer service initiatives and Image Activation.

The company, which sees adjusted earnings per share growth in the high single-digit to low double-digit range beyond 2013, expects its fourth-quarter results to benefit from the 47 Image Activation restaurants that reopened late in the third quarter and early in the fourth quarter.

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