Refranchising Efforts Serve up Gains at Wendy's

01/28/2020 5:00 am EST

Focus: CONSUMER

John Staszak

Securities Analyst: Consumer Discretionary & Consumer Staples, Argus Research Corporation

Wendy’s (WEN) operates quick-service restaurants, with approximately 6,500 franchise and company-owned restaurants in the U.S. and 30 countries. With a market cap of approximately $4.8 billion, the shares are generally considered mid-cap growth, notes John Staszak, an analyst with Argus Research.

We believe that Wendy’s has revitalized its brand over the last three years by selling more than 800 company-owned restaurants. By the end of 2017, WEN had sold nearly all company-owned restaurants that it had planned to sell, and just over 30 locations are now company-owned.

Meanwhile, in 2018, Wendy’s built 44 new restaurants in North America, and opened nine international locations. The company and its franchisees have already remodeled 48% of restaurants, and the remodeled restaurants are generating significantly greater revenue on average than older locations.

The company is also working to strengthen its brand through new product launches and stepped-up marketing. The recent refranchising efforts will increase rent and royalties (4% of franchisee revenue), and provide a more reliable sales and earnings stream.

Although operating earnings typically decline following a refranchising, Wendy’s expects EBITDA to be unaffected, driven by $30 million in annual G&A savings. As part of the refranchising, Wendy’s expects franchisees to remodel their restaurants. Remodeling will cost $400,000-$750,000 per restaurant, and is an important part of the company’s efforts to boost its brand image.

Key risks for Wendy’s include commodity inflation, fierce competition from McDonald’s and Burger King, and increased labor and utility costs. In addition, concerns about health and obesity could lead to reduced spending on fast food.

We believe that WEN’s projected 2020 EV/EBITDA multiple of 13.8 inadequately reflects the higher margins and more stable revenue streams that occur when nearly all restaurants are owned by franchisees. We believe that the stock merits a higher multiple of 16.4. We are maintaining our buy rating and raising our target price to $26 a share.

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