Bruce Bennett
Bruce Bennett
My recommendation for The Wendy’s Company (NASDAQ:WEN) is a hold rating, as I remain concerned about WEN's ability to improve its same store sales (SSS) structurally. I also think that management FY24 guidance is hard to meet or beat as the underlying assumptions seem to be quite aggressive, especially considering the extremely competitive environment. I think it is best to just stay on the sidelines until WEN actually shows improvements. Note that I previously rated a hold rating for WEN as I wanted to be sure of the business SSS strength (I intended to validate this with the 4Q23 SSS performance) before believing that the business SSS is going to turn structurally better.
The business reported 4Q23 total revenue growth of 0.8% from $536.5 million to $540.7 million, missing the consensus estimate by ~$7.4 million. Restaurant-level profits (RLP) fell 11.2% from $33 million to $29.3 million. However, better cost management led to operating income growing 3.1% to $86.6 million. Consequently, adj. EBITDA increased modestly by 2.6% to $126.6 million. The stock fell ~10% post-results, and I believe the reason was because SSS failed to perform again. Domestic SSS came in at 0.9%, which represented the third consecutive quarter of sequential decline. Even on a 2-year stack basis, 4Q23 performance was in sequential decline as well, and management attributed the weak performance to broader category challenges impacting traffic in 4Q23. This suggests that the competitive environment is a lot fiercer than expected, especially with inflation remaining sticky in the country.
Building on this fierce competitive environment narrative, it makes it hard to believe that WEN can beat management's FY24 SSS outlook with ease. Management guided global system sales growth of 5-6% and SSS growth of 3-4%. This implies global SSS to sustain vs. FY23 level but accelerate strongly from 4Q23 level. At the top, revenue is only expected to grow by 3%. We can tell from the guide that the investments made are going to be huge as they literally muted out any positive top-line contribution: adj. EBITDA guided to $535–$545 million, which implies low-single-digit percentage growth, essentially flat vs. last year despite revenue growth. This again makes WEN a lot less attractive for investing in FY24, as profits are going to stay depressed.
Now, that is not to say that WEN cannot meet this guidance; it is just that the expectation is high. For WEN to meet or beat this set of guidelines, I think it will come down to how it pulls off its breakfast penetration strategy. Despite the fact that QSR breakfast customers tend to be regulars, WEN has failed to attract them thus far, which, in my opinion, is due to poor oversight from the previous set of management. Encouragingly, the new leadership, headed by CEO Kirk Tanner, has laid out a fairly clear investment plan, with a heavy emphasis on breakfast, to boost advertising spending and enhance sales trends. More specifically, WEN intends to invest $55 million (or 90% of the total) in incremental breakfast advertising across the US and Canada over the next two years, with $15 million going toward digital growth in 2024 (mainly towards app upgrades and more personalized marketing capabilities) and $30 million going toward the rollout of digital menu boards across all US company stores over the same time period. These investments are substantial because they total approximately $100 million, or 20% of the adjusted EBITDA for FY23. The end goal is to drive a 50% increase in breakfast sales in the next two years to ~$4.5k per week (my estimates), with a longer-term target of $6k per week, SSS growth of 3-4% in 2024 (a step up from the low single-digits profile previously), and 100 bps of US store margin expansion.
I like to touch more on the competition aspect of the breakfast day part, which is a key reason for me feeling uncertain about the WEN FY24 guide. Firstly, there is a lot of QSR competition in this space. For example, McDonald’s (MCD) has almost 13,500 stores, Dunkin Donuts (DNKN) has close to 30,000, Starbucks (SBUX) has around 16,500 stores, and many others. The impact of competition is clearly evident in the domestic SSS performance in 4Q23. Secondly, management guidance implies that WEN is going to capture quite a substantial amount of market share within a short period of time. In the guide, management expects to generate a 50% increase in weekly US breakfast sales per restaurant. In 1Q22, they mentioned that they will get to $3 to $3.5k per week by FY22. Suppose that is the same level for FY23. Taking the low point ($3k), it implies FY24 breakfast sales per restaurant to be ~$4.5k/week; this translates to around $1.4 billion (using the FY23 number of US stores) of annual restaurant sales, which translates to an increment of ~$500 million in 1 year. This is a massive amount relative to WEN systemwide sales today (FY23 $7.2 billion), representing a ~7% increase in one year. From a marketing return on investment (ROI) perspective, the expected return is extremely lucrative. In the guide, management expects to invest $55 million in incremental advertising, which means an ROI of almost 10x ($500/55 million). I don’t know if such opportunities really exist, because if they do, I find it hard to believe that established peers are not aggressively pursuing them.
to return into their morning routine. So we're feeling very confident that we can get to the low end of that 10% to 20% growth on a full-year basis and really be squarely in that $3000 to $3500 per week per restaurant, by the end of the year. from: 4Q2023 earnings call
All in all, I think the focus is going to be on FY24 SSS improvement and breakfast growth, and my view is that a lot of investors are going to stay on the sidelines (like myself) to observe actual improvements before deciding to invest in the stock. For now, the execution and expectation risks are simply too high for me to invest.
(Side note: I’m putting aside valuation model for this update as FY24 is simply too uncertain for me to make educated assumptions).
My recommendation for WEN is still a hold, driven by concerns over its SSS performance and the ambitious FY24 guidance in a fiercely competitive market. For FY24, my key uncertainty lies in management's expectation of substantial market share capture. While the new leadership's clear plan is encouraging, execution risks and high expectations forced me to take a prudent wait-and-see approach until tangible improvements materialize.