Wendy's Misses Q3 Earnings Estimates on Higher Food Costs

The Wendy’s Company (WEN) recently posted sluggish third-quarter 2014 results as both earnings and revenues missed the Zacks Consensus Estimate. However, the company reaffirmed its outlook for 2014.

Share price of the company increased 2.4%, despite the miss, as investors’ confidence was possibly boosted by the company’s introduction of a cost expense-reduction initiative of $30 million. In our view, this cost-saving initiative would benefit the company especially at a time when higher beef costs and the implementation of the Affordable Care Act are denting margins. Additionally, the company's reaffirmed guidance and the dividend hike (the company's board of directors increased its quarterly dividend by 10% to 5.5 cents per share) boosted investors confidence in the stock.

Wendy’s third-quarter 2014 adjusted earnings of 8 cents per share missed the Zacks Consensus Estimate of 9 cents by 11.1%, mainly due to a decline in revenues. However, earnings were flat year over year.

The Wendy's Company - Earnings Surprise | FindTheBest

Total revenue in the quarter declined 20% year over year to $512.5 million. The downside reflects a reduction in the number of company-operated restaurants as a result of the system optimization initiative. Also, an image activation reimaging program led to some temporary restaurant closures, which negatively affected revenues. The company had also expected a significant year-over-year increase in temporary restaurant closures due to speeding up of reimaging activity.

The top line also missed the Zacks Consensus Estimate of $517.0 million by 0.9%, which was possibly due to sluggish comps growth.

Behind the Headline Numbers

Comps at company-operated restaurants increased 2%, comparing unfavorably with 3.9% improvement in the prior quarter. Comps at North American franchise-operated restaurants were up 0.5%, comparing unfavorably from the second-quarter comps growth of 3.1%.

The company expects comps growth to be positive in the fourth quarter of 2014.

Company-operated restaurant margin decreased 10 basis points (bps) to 15.5%. The decline was mostly due to an increase in commodity costs, especially beef prices, and rise in temporary Image Activation restaurant closure weeks of nearly two and a half times, partly offset by the positive impact of system optimization.

General and administrative expense was $65.8 million, down 13.9% year over year in the third quarter of 2014. The decrease resulted primarily from cost savings related to the company's system optimization initiative, as well as lower incentive compensation and a reduction in Image Activation incentive expense.

Adjusted earnings before interest, taxes, depreciation and amortization (:EBITDA) were down 4.7% to $94.1 million, below the company’s expectations of it remaining flat.

Operating profit was $46.9, soaring 75% primarily due to year-over-year reductions in general and administrative expense.

2014 Outlook Reiterated

Wendy’s has reiterated the 2014 outlook. The company projects adjusted earnings to be within 34–36 cents per share, up from the 2013 levels. Management expects adjusted EBITDA to be $390 million representing 6% year-over-year increase.

The company expects the average same-restaurant sales growth of approximately 2.5% at company-operated restaurants in 2014. Wendy’s expects company-operated restaurant margin in the range of 15.5% to 15.7%, down from the prior guidance of margins in the range of 16.3% to 16.8%. The guidance reflects higher beef costs in the coming quarter.

Capital expenditures are expected in the range of $280 to $290 million, including approximately $215 million for company-operated image activation of restaurants. The company expects about $15 million reduction in interest expense, resulting from the company's 2013 debt restructuring.

The company plans to reimage 200 company-operated restaurants, including 35 scrape and rebuilds, in addition to the reimaging of 175 to 200 franchise restaurants. The company expects its total 2014 depreciation and amortization expense to decrease approximately 10% compared with 2013, including the impact of accelerated depreciation in both years, primarily as a result of the system optimization initiative.

Restaurant Ownership and Reimaging

As part of its ongoing restaurant ownership optimization effort, Wendy’s sold 12 North America restaurants to franchisees during the third quarter. The company also acquired three restaurants from franchisees during the quarter.

In addition, the company's previously announced initiative to further optimize its restaurant portfolio with the sale of 135 company-operated restaurants in Canada remains on track. The company expects to close these sales in the first quarter of 2015.

Company on Track For 435 to 460 New & Reimaged System-Wide Restaurants in 2014

The company remains on track to reimage 200 company-operated restaurants and now expects to reimage 175 to 200 franchise-operated restaurants, this year. Wendy’s has also planned 15 new company-operated Image Activation restaurants and 45 new franchise-operated Image Activation restaurants in 2014.

The company continues to aim the implementation of Image Activation in 85% of its company-operated restaurants and 35% of the North America system by 2017-end.

Company to Realign & Reinvest in Restaurant Growth and Technology

Wendy’s announced a plan to realign and reinvest especially in restaurant development and consumer-facing technology. This initiative, along with the previously announced sale of its Canadian company-operated restaurants, will result in expense reduction of about $30 million, a small part of which will be achieved in 2014 and the rest in 2015.

The company expects to realize efficiencies primarily through the realignment of its U.S. field operations and savings at its Restaurant Support Center in Dublin, OH. Associated with this initiative, the company expects to record total costs related to this initiative of around $20 to $25 million, primarily during the fourth quarter of 2014 and first-half 2015.

The company expects general and administrative expense in 2015 to be approximately $250 million after realization of nearly $30 million in expected savings. The company expects that cost increases related to higher incentive compensation, wage and benefit inflation and a 53rd operating week will partially offset these savings.

Our Take

Despite sluggish sales, the decent earnings performance signals that the restaurateur is successfully transitioning itself and working on its cost structure. Menu innovation, reimaging of units, net domestic unit growth and international expansion bode well for the near future. Comps also posted a decent show. However, an increase in commodity costs remains a headwind for the company. Moreover, reduction in company-owned restaurants is expected to put sales under pressure in the near term.

Wendy’s presently has a Zacks Rank #2 (Buy). Better-ranked stocks in the same industry include BJ's Restaurants, Inc. (BJRI), DineEquity, Inc. (DIN) and Ruby Tuesday, Inc. (RT). All these stocks sport a Zacks Rank #1 (Strong Buy).

Read the Full Research Report on BJRI
Read the Full Research Report on RT
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Read the Full Research Report on DIN


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