Why Wendy's Is Losing Momentum

Aug. 5.14 | About: The Wendy's (WEN)

Summary

Turnaround was robust over the past year, but growth trajectory has slowed.

Wendy's is suffering from shifting consumer preferences, just as its competitors are.

Growth potential limited in a saturated U.S. market without plans for international expansion.

It appears that after a couple of really good years, The Wendy's Company (NYSE:WEN) is running out of steam. The stock had a great run last year, soaring from less than $5 per share all the way to $9 per share. In all, the stock returned more than 85% in 2013, then proceeded to run up even further to $10 per share this year.

But over the past several months, Wendy's has run out of steam. The stock has come well off of its 52-week highs, and in fact is now down this year. That lags behind the gains of the broader market.

What's happening to Wendy's is happening to all sorts of fast food chains in the United States, including McDonald's (NYSE:MCD) and Yum Brands (NYSE:YUM). Put simply, the saturated fast food landscape and the financial struggles of the fast-food consumer are putting a lid on domestic growth potential.

Here's why Wendy's turnaround is fading fast in the United States, and what it can do to get momentum back on its side.

U.S. growth looking bleak

Most fast food companies are finding it hard to produce growth in the United States these days. The low-income customer that makes up the core fast food demographic is still struggling, meaning there's only so much spending on fast food.

Indeed, McDonald's and Yum Brands both posted fairly unimpressive numbers last quarter, at least as far as the U.S. is concerned. McDonald's actually saw same-restaurant sales, which measures sales at locations open at least one year, decline in the U.S. by 1.5%, driven by falling guest traffic. Source: Earnings release

Yum Brands wasn't a whole lot better. Its Taco Bell brand registered just 2% growth in U.S. same-store sales. Meanwhile, its other core brands, KFC and Pizza Hut, posted same-restaurant sales declines of 2% and 4%, respectively.

Wendy's had been posting stellar results for several quarters, as it benefited from increased franchise activity and a rejuvenated menu. Indeed, it succeeded in luring customers back in with its Right Price Right Size menu, with a number of new items at varying price points.

This, along with improved earnings as a result of selling a lot of restaurants to franchisees, boosted earnings last year. But the benefits of franchising are wearing off as the company nears completion of the process, and same-store sales increased just 1% last quarter.

That means Wendy's is starting to mirror its larger, struggling peers in the United States. But while McDonald's and Yum Brands have a remaining growth outlet in the form of international expansion, no such option exists yet for Wendy's.

Wendy's needs to leave the comforts of home

What separates McDonald's and Yum Brands from Wendy's is their potential for international growth. Both of them have established firm roots abroad, especially in the emerging markets, where growth potential far exceeds that of mature markets such as the United States.

McDonald's and Yum Brands know that their growth will be limited in the United States. In response, they have ambitious plans to grow internationally. For example, McDonald's plans to spend as much as $3 billion this year to open at least 1,500 new restaurants, the vast majority of which will be located in developing markets.

For its part, Yum Brands opened 298 restaurants last quarter alone, 78% of which were in the emerging markets. The company intends to open as many as 700 new restaurants this year in China alone.

What's holding Wendy's back is that its restaurants are located almost entirely in North America. Of Wendy's 5,374 total restaurants at the end of last year, just 399 were located outside North America. That means its international restaurants make up just 7% of its total restaurants. Source: Wendy's 10-Q

Curiously, Wendy's management seems content to stand still in North America. The company is counting on continued franchising will which reach a limit, as well as consumer engagement to drive sales. The company mentions the possibility of global growth in its investor presentations, but doesn't elaborate on how and when that will happen.

The bottom line is that Wendy's will soon realize what McDonald's and Yum Brands realized long ago. Franchising and new store openings will only take you so far in the United States. International expansion is the growth engine of the future, and Wendy's is missing out.

Disclosure: The author is long MCD. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.