The fast food industry is highly competitive but always seems to provide great investment opportunities. Warren Buffett has Dairy Queen. Biglari has built his (short) career on the restaurant industry. McDonald's (MCD) has been rewarding investors for decades.
Currently Nelson Peltz’s company, Trian Fund Management LP, is attempting to create its own success story in the industry with is controlling stake in Wendy’s/Arby’s Group (WEN). After merging Arby’s with Wendy’s, the co-branded company became the third largest fast food company in the world behind McDonald’s and YUM Brands (YUM). Wendy’s now consists of 6,630 Wendy’s units and 3,756 Arby’s units which are mostly located in North America. Trian Fund owns 16.5% of the outstanding shares.
There are a hand-full of models that the company can pursue over the coming years to greatly increase shareholder value.
Remodeling Menus, Buildings and the Map
Currently, management is tacking the menu of both brands. They have a stated goal of having breakfast in all North American units by 2011. The probability of financial success of breakfast is debatable. MCD dominates this area already and the breakfast ticket is typically smaller than lunch. This is obviously a risky plan as Wendy’s has already admitted defeat during its first breakfast attempt. Time will tell. On a more successful note, both brands are offering expanded value meals and value menu items. This has the effect of squeezing margins in hopes of increased traffic. Also, Wendy’s has had great success after introducing new boneless and spicy chicken offerings.
The next project is opening more co-branded units, most likely at interstate-off-ramp locations. It’s not clear whether these units will be built new or converted existing units. Currently older Arby’s units are being remolded with great success. Management says that Arby’s units created “significant increases in traffic”. 75% of all Arby’s will be remolded in the next 3 years.
Third, international expansion opens up the company to tons of opportunity as well as new risks. While the company has shut down its 70 units in slow growing Japan, it has begun exploring options in Southeast Asian and the Middle East. Only time will tell how successful this expansion will be. An investor will need to exercise great patient s in this endeavor. Management sees the potential for 8,000 new international stores. A dual branded unit will be opening in Dubai early this year.
Improving Costs, Royalties and Performance
On the cost cutting front, the company is creating a supply co-op for the Wendy’s brand that mimics the existing Arby’s co-op (ARCOP). Also, cost cuts and combined operations are still being digested following the merger but management says things are ahead of schedule. Also, Arby’s can further convert company owned stores (1,176 of 3,756 total units) into franchisees to meet the ratio of Wendy’s (1,406 of 6,630 total units). Additionally, management may push the Arby’s royalty fee (3.6%) closer to Wendy’s (4%) over time.
Finally, management will continue to manage the quality of the existing store base. In 2008, 96 under performing units were closed while 82 new units were opened. For more detail on these initiatives, view Wendy’s most recent presentation.
Quality Balance Sheet
The company seems to recognize its undervalued stock as it has authorized another $100M in buybacks (for reference: Market Cap $2.1B). Shares have been repurchased from $3.50 - $5.15 over the past year. The average buyback was $4.77. The annual dividend payment of $27M is easily covered with the +$600M of cash on hand. The balance sheet carries $1.5B in long-term debt. With a debt-to-equity ratio of 0.68, that’s less debt than YUM (3.65), MCD (0.84), and BKC (0.87).
The YUM Brands Model
For the long-term investor, there may be another avenue of growth provided by the unique management of WEN. Within the company’s SEC filings lies this interesting arrangement (emphasis mine):
On November 1, 2005, Nelson Peltz, our Chairman and former Chief Executive Officer, Peter W. May, our Vice Chairman and former President and Chief Operating Officer, and Edward P. Garden, our Former Vice Chairman and a member of our Board of Directors (collectively, the “Principals”), started a series of equity investment funds (the “Funds”) that are separate and distinct from the Company and that are being managed by the Principals and certain other former senior officers and former employees of the Company through a management company (the “Management Company”) formed by the Principals. The investment strategy of the Funds is to achieve capital appreciation by investing in equity securities of publicly traded companies and effecting positive change in those companies through active influence and involvement. Before agreeing to acquire more than 50% of the outstanding voting securities of a company in the quick service restaurant industry, the Principals have agreed to offer us such acquisition opportunity, which may result in acquisition opportunities being made available to us from time to time.
This arrangement may one day provide the company with undervalued and/or poorly managed quick service brands that it can improve upon or expand into overseas markets.
Arby’s already owns a dessert maker named TJ Cinnamons and sells its products through a few stand alone units and Arby’s units. This unit seems to have little potential but was bought after the company got its self into financial trouble. Also, the company has entered a real estate joint venture with Tim Horton’s (TimWen) in Canada. This unit created $19M in pretax revenue in the first 9 months of 2009.
Conclusion
For a long term investor, Wendy’s deserves more attention. With the help of a shareholder friendly management, the company has many opportunities ahead. With a low probability of dilution, room to grow, a strong brand, buybacks, and a clean balance sheet, Wendy’s makes for a risk-averse investment. All that, and it sells under its listed book value and pays a modest 1.3% dividend while you wait.
The growth avenues ahead all have unique risks but take peace in the fact that management is working for the share holders and not for analysts or pretty quarterly numbers. Plus, I use it as an excuse to eat more Frosties.
Disclosure: Author holds long positions in WEN, SNS
