Wendy's Looks Ready For a Big Breakout

| About: The Wendy's (WEN)

By Tommy Hughe

Wendy's Corporation (NYSE:WEN) has been trading near all-time lows since late 2008. Hit hard by the US financial crisis, the ensuing recession and an unprofitable merger with Arby's, many are asking when Wendy's will bounce back. The stock, which lost nearly 75% of its value in one day, has had a volatile year. Currently trading around $5, WEN has been stuck in a trading range with little hopes of breaking out. What will it take to bring Wendy's back to its peak? Momentum is weak and without direction, I think the answer is a return to good fundamentals. Wendy's is current p/e is over 48 with the forward looking version at 24. This makes Wendy's way overpriced. Price to earnings for the the Dow stocks range between 9-18 with an average dividend around 3%. Wendy's is returning 1.5%.

Earnings in 2011 were weak compared to analysts estimates and are only up about 1.5% from 2010. Loss in the third quarter of 2011 widened over the previous year to $4 million despite an increase in revenue. However, total revenue for the quarter grew by 2% to $611.4 million. Analysts were expecting a much larger increase to $619 million. A large portion of costs were attributed to Arby's, which Wendy's sold earlier in the year. Wendy's sold an 85% stake in Arby's for a combined cash/debt deal totaling $320 million. During the conference call CEO Roland Smith reaffirmed 2011 guidance. Total growth for 2011 is expected to be 2%. Operating margins for Wendy's owned and operated stores is expected to be a full percent off of 2010, due in part to rising commodity prices. Fourth quarter earnings are expected to be released in late January of 2012. So far management has been very tight lipped about its expectations for 2012.

Wendy's has the future in mind. Forward thinking management is implementing several plans to boost profits and share price. On the sales front, Wendy's is opening its stores for breakfast. Breakfast sales account for nearly 29% of revenu in the fast food arena. Wendy's is developing a line of high quality low cost breakfast options and, of course, good coffee. Another strength, mentioned by CFO William Hare, is Wendy's “ability to generate free cash flow.” This cash flow is being reinvested in store remodels and updates, among other plans. Wendy's is also engaged in a stock repurchase plan in an effort to boost share price and investor confidence. Wendy's repurchased $250 million in shares during 2011. Since the inception of the plan Wendy's has bought 82 million shares at an average cost of $4.84. In 2012 Wendy's is expecting to open 34 new stores, including franchises and overseas operations.

Competitors Yum Brands (NYSE:YUM) and McDonald's (NYSE:MCD) are more attractive on paper, and both can be clear winners. However, a look at the charts suggests they're played out. Since 2009 YUM has increased over 100% from under $25 to near $60. YUM's momentum is waning, and its market indicators are divergent. The same is true for McDonalds. McDonalds has been trending up sine 2003 posting gains over 900% in that time and completely weathering the global financial storm. I'm not saying either of these companies is in for a major correction, but the bull is tired -- they won't be advancing this year.

YUM recently announced an increase of its guidance for 2011 EPS growth from at least 12% to at least 13%. In the same statement 2012 EPS growth was estimated at 10%.This announcement was on top of disappointing US results and strength in foreign and emerging markets. The forward gains are based on estimates of international growth and currency conversion rates. Given the state of the international economy I would not count on that. China is expecting to slow by a half percent next year and to have entered a period of extended economic slowdown. McDonalds is expected to grow at the average rate of 9.5% over the next five years. I think this is fairly optimistic since average global growth is estimated at 2.5%.

On the long term charts Wendy's looks like it has been trading flat for several years. Momentum is bullish but almost non-existent. All of the volume spikes are bullish, appearing on up days, and support seems to be there. The short term charts show something else entirely, a choppy and highly volatile market. WEN has been trading in a range from $3.60 to $5.75 and is now approaching resistance. Again, momentum is bullish but barely there, I think traders are waiting for fourth quarter earnings. If Wendy's makes a break above the range it will go straight to $20 before encountering any serious resistance.

Wendy's is in good shape to break out. Management is dedicated to improving business. Remodeling stores for customer appeal and comfort, opening for breakfast and focusing on same store sales are a recipe for success. I think that the entire fast food market is saturated, but Wendy's has room to grow by way of taking market share. Wendy's has been struggling for so long I think that the stock price reflects a bare bones value of the company. Once Arby's is fully off the books and capital expenditures begin to pay off Wendy's will do quite well. Positive earnings growth will bring the P/E ratio back into line with the general market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.