Those who are thinking about buying into Shake Shack (NYSE: SHAK) should take a look a look at America's original quality hamburger chain, Wendy's (NASDAQ: WEN), before putting their money where their mouth is. The latest set of financial numbers shows us that Wendy's is in terrible shape and could be shaking fast.
The most worrying number at Wendy's is the revenue, which is currently in free fall. In December 2013, Wendy's reported a TTM revenue of $2.497 billion, a number that fell to $2.076 billion by December 2014 and $1.88 billion by December 2015. Wendy's lost around $602 million, or about one fourth of its revenue, in just two years.
To make matters worse, Wendy's was trading at just $9.45 a share on Feb. 15, 2016. Shake Shack was trading at $34.08 a share on the same day, even though it only reported a TTM revenue of $174.3 million and a net income of -$11.45 million on Sept. 30, 2015. Wendy's reported a net income of $161.14 million on Dec. 31, 2015.
Is Wendy's a Value Bargain?
Despite its revenue collapse, Wendy's did exhibit some characteristics of a value bargain. In addition to being cheap, Wendy's offered investors a dividend yield of 2.38% and a return on income of 6.48%.
Although its cash situation was not great, Wendy's reported a free cash flow of just $7.817, $175.7 million in cash and short-term investments, and $190.81 million in cash from operations on Dec. 31, 2015. This means that Wendy's may not have the resources to stay in operation.
It may have to dramatically trim operations soon or sell off assets such as real estate to stay in business. One possibility might be to close underperforming locations. If Wendy's does not, it might face the death spiral or acquisition at some point in the near future.
Is Wendy's an Acquisition Target?
Another potential fate for Wendy's is acquisition. It might survive as part of a larger chain, such as Jack N' the Box (NASDAQ: JAK) or CE Restaurants, which owns Hardees and Carl's Junior. A darkhorse savior could be Warren Buffett; his Berkshire Hathaway (NYSE: BRK.B) already owns one lowbrow fast food chain in the form of Dairy Queen.
Acquisition is on the table for Wendy's because it definitely is cheap right now. The burger chain had a market capitalization of $2.5484 billion and an enterprise value of $4.812 billion.
Wendy's real estate alone and its locations could be worth something, even if its brand is not. A major problem is that Wendy's appears to be a weak company with a weak brand.
Weak Company, Weak Brand
Something to remember is that a strong brand can sustain a weak company, which appears to be the case at McDonalds (NYSE: MCD), while a strong company can sustain a weak brand, as is the case at American Express.
The customer loyalty a strong brand creates can generate enough sales to sustain a very weak company, as has happened at Sears for decades for example. A strong company can take the marketing and strategic steps needed to prop up a weak brand, as American Express has been doing for years.
Unfortunately, the Wendy's brand is not strong enough to prop up the chain, while the management seems to lack the expertise or resources needed to reinvigorate the brand. The weak brand cannot generate the sales the company needs, while the company cannot take the steps necessary to grow sales.
Wendy's has been trying to revive its brand with clever advertising, but it is not clear that has worked. A big problem here is that the clever hipster-oriented advertising might backfire and scare away Wendy's working class customers.
Wendy's Woes Don't Bode Well for Shake Shack
Wendy's woes point to a rather uncertain future for Shake Shack. Wendy's was the original better burger chain, founded by Dave Thomas in 1969 to provide a higher quality alternative to McDonald's and Burger King.
Over the years, Wendy's has struggled to maintain that image. Attempts to differentiate itself from competitors with such gimmicks as salad bars did not lead to lasting success. A series of overseas expansions was spectacularly unsuccessful, with the chain pulling out of country after country.
One reason why Wendy's has had such an unstable history was its inability to maintain the higher quality its founder stressed. Maintaining high standards in fast food can be difficult, as the recent E coli debacle at Chipotle Mexican Grill (NYSE: CMG) has demonstrated.
Therefore, it has to be asked how a chain like Shake Shack can avoid becoming another Wendy's, which is experiencing an early period of expansion, only to get bogged down in logistical and managerial problems that lead to low quality, which destroys the brand. The brand, after all, is being built on the idea of quality.
Wendy's Brand Weakness
A major cause of Wendy's brand weakness is its inconsistency. The chain has never been able to make up its mind whether it is a quality burger chain (a la In N Out Burger), another McDonald's, or something else. Over the years, it has experimented with a wide variety of menu items and advertising gimmicks.
Wendy's has also never settled on a target market; at various times, its advertising has targeted children, families, working people, young men, and lately, hipsters. Obviously, a brand that cannot decide on who its core audience is will be incapable of effective marketing.
Wendy's has some important lessons to teach fast-food upstarts like Shake Shack and Chipotle. The most important of which is to always maintain quality and consistency, because in the world of fast food, your brand is worthless without them. That's a lesson Wendy's has learned the hard way, and a lesson that Shake Shack and Chipotle could learn in the future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.