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Wendy’s: Will this fast food company get you fast returns?

Tuesday, June 7th, 2016

One type of business that fascinates me is the fast food restaurant business. It is a fairly simple concept, and can be a high volume business.

I do worry a bit about the increasing minimum-wage in future years, however, I think the smart fast food companies will find more ways to automate their business.

Unfortunately, those who will get hurt are mostly high school and college kids just trying to earn some extra money.

I thought I would take a look at Wendy's fast food restaurant, which is known as The Wendy's Company and trades under the stock symbol WEN.

Based on market capitalization the company is not that big, with a market cap of $2.7 billion. The stock has a rather tight trading range, with a 52-week high of $11.56 and 52-week low of $8.43; the current price is just over $10/share.

Wendy's Company was founded back in 1884 and has done many different types of business, but in the early 90’s they became known of more as a food business. In addition to Wendy's restaurants, they also own another company known as TJ Cinnamons and have an 18 1/2% stake in Arby's fast food sandwich chain.

Starting off with valuation ratios, Wendy’s current price-to-earnings ratio is 19.8, well below the industry average of 26.1. Price-to-sales also looks attractive at 1.5, compared to the industry average of 2.6. Just when I start liking the way things look, I discovered the price-to-tangible book value is not material, versus the industry at 221.

It is important to understand what these intangible assets are if you hold this company, or are considering investing in it. Price-to-cash flow looks good at 9, also well below the industry at 15.8.

Overall, the valuation ratios look very attractive, with the exception of the price-to-tangible book value.

The company pays an attractive dividend of 2.4% and only uses 46% of the earnings to pay it. It is worth noting they have a five-year growth rate on that dividend, of 26.3%.

Looking at sales growth year-over-year for the last 12 months, their sales have dropped by 7.4%, when the industry of quick service restaurants increased by 3%. However, earnings-per-share increased by 112% year-over-year for the last 12 months, when the industry only saw an increase of 14.5%.

A quick review of the income statement revealed some items worth looking into. 

I noticed a large drop of about $20 million in the cost of revenue, along with unusual income of $42 million and non-operating investment income of $52 million. This all occurred in the quarter ending January 3, 2016.

Looking at the financial strength of the company, I noticed the industry average current ratio (which displays the liquidity of a company) was 0.9, and Wendy's was much higher at 2.4.

In addition, I discovered the industry of quick service restaurants is a high-debt industry, with an average debt-to-equity of 235%. Wendy's is higher than that average, at 341%.

The company debt over the last year is up over $1 billion to $2.5 billion, however the equity has fallen by $1 billion to $733 million.

The company bought back roughly 100 million shares, which explains the reduction in cash.

However, it appears they could've borrowed the money to buy back the stock, which is not always the prudent thing to do. I would much rather see them buy back stock with extra cash, or from a high cash flow.

And don't forget about all those intangible assets of $1.3 billion that could be written off, if proved not to be worth what they carried on the books for.

To sum it up, we have rising debt, declining equity and a fairly large amount of intangible assets. Not a good combination in order to call this a financially strong company.

At this point I have no interest in investing into this fast food restaurant, however, I was still curious what the earnings-per-share estimate were going forward.

Looking at the earnings per-share for the year ending December 2017, the mean estimates on a GAAP basis is $0.42/share. With the stock trading just over $10/share, this tells me investors are paying 24 times forward earnings, which is a little on the pricey side.

We are conservative in our investment management and sell a company at 16.5 times, which is the 40 year average.

I would have to say to “pass” on buying or holding The Wendy’s Company. There are too many warning signs, and the fast food restaurant industry is very competitive with many different players.

If I can't find a company in which I won’t overpay for the earnings and that has a very strong balance sheet, then I will hold on to my money until I find one that is.

Do you have a question or a company you would like us to take a look at?
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