Whats Going On @ Wendy's

2/3/11

I’m sure that several of those following the fast food industry have noticed Wendy’s/Arby’s (WEN) recent two-week 15% run up (which is gaining even as I type this). It may seem very undeserved, since most of this can be accounted to their announcement that they will be selling the Arby’s franchise…and it most likely is.

First things first, I must disclose that I have owned this stock for just over 2 years and bought it while still in undergrad, in the depths of the recession, since, “it would be impossible for anyone selling Junior Bacon Cheeseburgers for a dollar to fail.” (These have gone up 30% in price since). I will admit that I did not really know what I was doing at the time, but it hindsight it wasn’t such a bad play. Furthermore this is going to be more of a macro analysis rather than number crunching because this stock is very volatile and seems to move for no reason at all on a constant basis (plus it’s much more fun to talk about Frosty's than technical analysis). With that said, let’s have at it…

What’s interesting about Wendy’s is that it was trading at over four times it’s current price in 2007. So what has happened in the last four years that has knocked Wendy’s over while allowing other fast foods to recover and prosper? Answer: An abundance of things. We’ll start with Arby’s. I’ve noted on this column before that the particular Arby’s in my hometown has done essentially no business outside of their first two months of operation a decade ago. Interestingly, the Wendy’s that was just over a mile away was closed three years ago because of declining sales but the Arby’s has tried to keep choppin’. It should be noted that within a half mile of this location stands a new Sonic (SONC), a new Five Guys, a Burger King, a McDonald’s (MCD), a Taco Bell (YUM), and countless pizza places. There is no way that Arby’s could stand this sort of competition. They rely on ads that push the quality of their roast beef and the health consciousness of their Market Fresh sandwiches. The roast beef is frozen for just as long as any other beef in the industry and then sits under a hot lamp for hours and most Market Fresh’s have enough calories for me to subsist on for a week. In short, outside of the Jamocha shake, Arby’s food is not good and has price points significantly higher than that of the competition. So yes, the Arby’s franchise has been pulling Wendy’s down and should be thrown overboard. This is basically the best alternative decision to what was originally a terrible decision. But, who is going to want to buy Arby’s? It’s like buying a professional hockey team in Arizona; a losing endeavor with no way out. I would expect that if an Arby’s sale ever does come to fruition it is not going to be anywhere near what Wendy’s wants for it.

For the remaining portion let’s imagine that Arby’s has been sold. Wendy’s also suffers compared to their competition because of their reluctance to expand overseas to the extent that McDonald’s and YUM have. McDonald’s is essentially everywhere and everyone knows about the YUM Chinese initiative. Both also deal extremely well with adversity. McDonald’s is constantly dealing with lawsuits (those Shrek glasses, Happy Meals, making kids fat, etc) and YUM has been able to handle people realizing that there is fake beef in Taco Bell tacos and the onslaught from Domino’s (DPZ) battling Pizza Hut. Wendy’s does not have these problems, mostly because people do not care enough to bring them up.

Like the others, Wendy’s has begun to offer healthier food choices like Garden Sensations Salads and natural cut fries. I have yet to try the fries, but they must be an improvement on the old ones. They also added shakes to their lineup to combat the McDonalds shakes. However, when there are generally comparable products and prices consumers look to things like timeliness of service and satisfaction and that is where McDonald’s dominates. Anyone who’s seen the CNBC special on McDonald’s has seen the living organism at work churning out finished products in no time. This goes against the convoluted idea that if the food takes a while to make it must be fresh.

On the financial front; it is very tough to get behind a stock that is barely treading water earnings wise. Based on their 2010 earnings of $0.14, Wendy’s has a P/E in the high 30s. Compare that to YUM in the low 20s and MCD at 16. So what does this high ratio tell us? It could mean that investors are very hopeful for the future and that earnings will start to accumulate. The alternative is that the stock is overpriced and those holding it are naïve. Personally I’d side with the former, mainly because it would be tough for earnings to go much lower, especially after the Arby’s sale. Additionally, the sale will allow the business to focus it’s efforts on the integral part of the business and not that roast beef pipe dream.

Lastly, everywhere you look recently there are reports on the rising costs of food. This is going to hurt Wendy’s just as much as the next guy, and people are not going to stop buying cheap fast food. The goal has to be to capitalize on this by proving that your food is the food to be buying at the time. Short term Wendy’s does not appear to be going anywhere, but with the eventual sale of Arby’s and a refocusing of corporate minds there is definite upside and this is what the high P/E indicates. Wendy’s should prosper in the future, both as an eating establishment and as a stock (but no more fish commercials, no one eats fish on a bun).

-Jeff