Wendy's Selloff Is A Blessing In Disguise
Summary
- Wendy's stock price has been selling-off along with the market in general.
- At this point, the stock is down 15% year-to-date while long-term prospects continue to be good.
- The company is expecting high sales and recovering earnings growth as its core business and growth initiatives are increasingly supporting the bottom line.
It is time to revisit my bullish Wendy's (NASDAQ:WEN) call after the stock dropped 21% in the week of its fourth-quarter earnings release. Everything started well as the stock quickly rallied to $24 after which the stock dropped along with the market. While I am writing this, the stock is down almost 15% since the start of the year as investors are selling everything - especially stocks that get hurt when consumer spending drops. Nonetheless, as the company is showing accelerating fundamentals, I continue to believe the company will be a solid long-term buy. In this case, think the stock market correction offers an incredible chance to buy Wendy's at a good price.
Source: The Wendy's Company
Here's What Happened In Q4
We delivered a very strong year of sales growth and have laid the foundation in 2019 to set the Wendy’s® brand up for future success.
- President & CEO Todd Penegor
This sentence from President and CEO Todd Penegor is a short but good summary of the fourth quarter where strength started all the way at the top. The company saw systemwide sales growth of 5.7% in North America and 9.8% international. When combining both, the global sales growth rate hits 5.9%. On a full-year basis, global sales are up 2.8% as total sales have accelerated towards the end of the fiscal year.
Moreover, and this number is even more important, North American same-store restaurant sales (hereafter referred to as 'comps') were up 4.3%. This is 410 basis points higher compared to the 0.2% growth rate in the last quarter of the 2018 fiscal year.
Unfortunately, the company-operated restaurant margin fell by 170 basis points to 14.3%. A mix of higher labor expenses, higher insurance costs, commodity inflation, and a lower customer count were more than offsetting better pricing and mix. This also implies that the company's comps were largely the result of a favorable price/mix. While this is a concerning trend, the good thing is that the company is showing strong sales growth that started almost at the same time when margins peaked.
Data by YCharts
Operating profit fell by 19.9% to $36.7 million in the fourth quarter. On a full-year basis, operating profit is up 5.1%. What seems like a pretty bad number is the result of higher franchise support costs due to the investments to support the US system in advance of the breakfast launch. These higher reorganization and realignment costs on top of lower net rental income were partially offset by lower general SG&A costs and higher franchise royalty revenues and fees. Note that the company finished 58% of its global reimaging investments, meaning that capital investments will remain elevated for the foreseeable future.
The good news is that sales are expected to rise to $12.0 to $12.5 billion. The lower bound of this range implies a total company-wide sales increase of 10.9% compared to the full-year 2019 sales result. Adjusted EBITDA is expected to rise to at least $425 million to $435 million compared to $412.8 million in 2019. This implies an improvement of 3.2%.
The graph below shows the factors influencing the 2020 EBITDA expectations. Interestingly, the company expects the benefits from its new breakfast to be equal to core growth. An extra selling week is expected to add almost the same amount.
Source: Wendy's Q4/2019 Earnings Presentation
Furthermore, the company once again reiterates its goal to maintain a payout ratio of at least 50% after the company has serviced its capital needs. Once cash has been paid out to investors, the company will use further access cash to reduce debt and/or repurchase shares.
Takeaway
The current business environment is as tough as it gets. While uncertainty is and always has been a factor when assessing stocks, we are currently dealing with a virus that has started to disrupt supply chains in China and could do the same to other economies as well. While it needs to be seen how bad things will get, the market has started to price in a lot of negativity as the S&P 500 had its fastest 10% drop in history.
Wendy's has done the same as I briefly mentioned in the intro. The stock is down 15% year-to-date as investors are selling everything that could suffer if consumers suddenly decide to stay at home.
Source: FINVIZ
While I am not going to try to predict the outcome of the coronavirus, I am adding to my dividend investments. In my opinion, a lot of stocks have long-term potential that should outweigh even severe short-term headwinds. Wendy's is one of these companies. While the first half of 2020 sales are impossible to predict, I expect the business turnaround to generate healthy long-term sales growth and rising margins after the reimaging investments have been completed. Once that happens, we are dealing with a stable dividend-paying corporation. Even at this point, the company is paying 2.50% per year. The valuation of roughly 29x forward earnings is not very 'cheap', but this is the result of the company's ongoing investments that have pressured bottom-line earnings despite solid sales growth.
All things considered, I continue to believe in Wendy's long-term success. I am looking forward to the first results from its nationwide breakfast launch and the impact of the corona disruptions.
Let me know what you think!
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