Fast food retailer Wendy's (WEN) has had a tough path during the past several years, but we believe conditions are slowly getting better. Revenue in its first quarter results, released May 8, grew just 2% year-over-year to $603 million, falling a bit short of consensus estimates. Earnings per share weren't robust, but were still in-line with consensus expectations at $0.03 compared to $0.01 in the same period a year ago. Adjusted EBITDA, a metric Wendy's has been using over the past few years, grew 21% year-over-year to $77.3 million.
Since the Great Recession, we've seen Wendy's mostly underperform its peers, but the firm is taking steps in the right direction to narrow the gap. North American same-store sales grew 1% year-over-year at company operated restaurants - not a terrible number and actually better than rival McDonald's (MCD), which saw same-store sales dip 1.2%. Franchise operated locations grew same-store sales just 0.6%, which we think is one of the issues with Wendy's. Although its franchisee base provides a nice source of high margin revenue, a lot of franchisees do not seem committed to keeping restaurant quality exceptionally high. Based on store visits to franchised McDonald's locations, we gather that the incentives for cleanliness and quality must be slightly higher for McDonald's owners relative to Wendy's owners.
However, we believe store redesigns, coupled with a strong economic outlook, could help boost Wendy's fortunes. Due to fantastic value oriented offerings, McDonald's and Taco Bell (YUM) have really dominated the fast food landscape over the past few years. The "higher quality" quick-serve dollars have gone increasingly towards the likes of Panera (PNRA) and Chipotle (CMG). Wendy's new message emphasizes the quality of its food, and in some cases, like its new chicken wrap, the healthfulness. Getting some trade-up from low-end rivals and cannibalizing some sales from the perceived healthy restaurants could push the needle with regard to sales.
On the cost-side, company operated operating margins improved 100 basis points year-over-year to 12.8%, which is still below the company's full-year target, but a clear improvement. With food cost increases likely moderating, in our view, and a new contract with two of its beverage suppliers, we think the firm's full-year restaurant operating margin target of 14.2%-14.5% seems attainable.
As for total profitability, Wendy's refinanced debt should result in $20 million in annual cost savings. Debt has eaten most of Wendy's earnings during the past few years, so any incremental savings gives the firm more flexibility with regard to internal investment and shareholder returns. In the fourth quarter of 2012, Wendy's signaled a commitment to shareholder returns by doubling its quarterly dividend to $0.04 per share and announcing a $100 million repurchase program.
Going forward, Wendy's reiterated its full-year same-store sales guidance of positive 2%-3% at North American company owned stores, while shuttering underproductive stores in North America and abroad. Capital expenditures are expected to total $245 million, which will certainly weigh on free cash flow in 2013, but we think the internal investment is necessary for the long-term sales and image improvement.
Although we like the direction that Wendy's is headed, we think the risk/reward at current levels is unattractive. We do not see substantial upside to warrant a position in the portfolio of our Best Ideas Newsletter at this time.