WENDY’S (WEN) DOWN OVER 10% TODAY – IT’S ABOUT BREAKFAST, RIGHT?? – NOT EXACTLY

Wendy’s stock is under a lot of pressure today, as a result of their entry (again) into the breakfast fray. The company said that they will spend about $20M to support the breakfast initiative. Analysts are obviously reacting skeptically, since WEN has previously experimented with breakfast, in 1985, 2007 and 2012. Since $20M amounts to less than $.09/share, it seems like a reduction of $2.70/share (as this written) is a bit overdone.  This is like when your wife criticizes you for not putting the top back on the toothpaste. It’s not about the toothpaste 😊

The chart below shows the outstanding price performance of WEN over the last five years. It has recently been selling for over 30x EPS estimates for 2019, and about 20x trailing EBITDA.

The table below provides some broad financial results over the last eight years, including the Arby’s divestiture. There have been lots of “puts and takes” from the income statement, and the GAAP earnings per share have fluctuated accordingly.  We show both the GAAP results and the Adjusted Earnings Per Share from Continuing Operations.

Operating Profit, as reported, was up from 2011 to 2014, has been “flat” from 2014 through 2018. As shown on the annual cash flow statement, we view Net Cash Generated from Operating Activities  as a reasonable proxy for how a company is really progressing. Though fluctuating, up and down during the period, THIS NUMBER IS LOWER NOW THAN IT WAS IN 2011. For our purposes here, we can (charitably) call it  “flat” as well.

EPS has been up sharply from 2011 until 2018, both adjusted or by GAAP. That “progress”, however, has been, since 2014 especially, the result of borrowing $1.3 billion to buy back about 150 million shares of stock. (Ain’t low interest rates grand?? ) Setting aside the modest remaining equity, reduced from the buyback: with $2.8 billion of long term debt against calendar ’18 EBITDA of  $379M ($250M of pretax, pre-interest, continuing operating profit + $129M of Depreciation), with debt now at 7.4x TTM EBITDA, one would have to conclude that this financial lever has been pulled.

CONCLUSION

Just a week ago we wrote an article describing how the stock of lots of companies (we referenced Starbucks (SBUX) and Restaurant Brands (QSR), in the wake of the breakdown of ULTA and OLLI), are “priced for perfection”, are vulnerable to the possibility of even a small disappointment. Wendy’s now comes into play from that standpoint. Over the last five years, WEN has provided essentially flat Operating Profit and Net Cash from Operating Activities. Earnings Per Share have been increased through leveraging the balance sheet and acquiring a great deal of stock. Down over 10% as we conclude this piece, WEN still sells at 30x estimated earnings for calendar ’19 and 19x our calculation of ‘18x EBITDA from continuing operations. Setting aside the prospect of success with breakfast, which will be expensive and time consuming, and is the focus of virtually all of today’s press coverage: We are not long or short WEN common stock, because we cannot predict how long investors will embrace “asset light” and “free cash flow” companies (this one has $2.8B of debt to service), but,  by all standards we consider reasonable, WEN is more than fully valued.

Roger Lipton