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Wendy's to propel growth with menu, restaurant revamps

A Heard on the Call report following 2Q earnings

Editor's Note: A previous version of this story has been updated to include additional information regarding Wendy's earnings projections and corrected information regarding Wendy's earnings for the July 3-ended second quarter.

The Wendy’s Co. reaffirmed its 2011 earnings growth outlook even as profit margins fell in the second quarter, mostly on higher commodity costs and some incremental advertising spending. 

Chief executive Roland Smith said margins would remain pressured for the balance of the year, but momentum for sales, traffic and average check would help the quick-service chain achieve its earnings growth target for this year and grow that metric between 10 percent and 15 percent annually starting in 2012.

Wendy’s is projecting earnings before interest, taxes, depreciation and amortization to be between $330 million and $340 million for fiscal 2011. Based on its growth goal of 10 percent to 15 percent EBITDA growth for 2012, the brand is targeting EBITDA of approximately $368 million to $385 million next year.

For the July 3-ended second quarter, Wendy’s earned $11.3 million, or 3 cents per share, compared with $10.7 million, or 3 cents per share, in the same year-ago quarter. The company’s income from continuing operations, which excludes former sister chain Arby’s results, totaled $11.4 million, compared with $5.4 million a year ago.

Same-store sales increased 2.3 percent at both company-owned and franchised locations in North America, Wendy’s said. Those increases included a 0.9-percent uptick in traffic and a 1.4-percent lift in the average check.

Same-store sales increases in July slowed to 1.7 percent, though Smith noted that transactions were still positive.

“We weren’t advertising a center-of-the-plate item,” he said. “There’s no reason to expect same-store sales are in jeopardy [in the third quarter].”

Smith added that the slight increase in both traffic and average check validated Wendy’s decision to be judicious with price increases this year.

Wendy’s has some room for further pricing action this year, he said, “but we won’t trade one quarter [of higher margins] for the benefit of the trend we’re seeing, which is consumers participating in our brand more often.”

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Menu innovation drives optimism

Several recent product introductions and the big upcoming roll-out of Dave’s Hot ’n Juicy Cheeseburger in October, “position us with the food quality of fast casual, but with the convenience and value of QSR,” Smith said.

Wendy’s promoted its revamped fries in April, Flavor Dipped Chicken Sandwiches and the My 99-cent Everyday Value Menu in May, and the Berry Almond Chicken Salad and Wild Berry Tea in June. Two new chicken items were added to the My 99-cent menu in July.

The premium burgers, set to debut Oct. 3, will have larger patties, premium ingredients and a butter-toasted bun, Smith said. The equipment needed to make these products costs about $20,000 per store on average. A major franchise group, WendPartners, thus far has not installed the new equipment, prompting a lawsuit from Wendy’s, which was not addressed in the call.

Breakfast, which 1,000 stores are scheduled to offer by the end of 2011, is providing an incremental sales lift of $150,000 per store on average, which represents a 10-percent lift in addition to Wendy’s $1.4 million average unit volume. Equipment and signage for the breakfast test has run about $25,000 per store.

Even though Wendy’s franchisees have been burned before by poorly executed attempts at breakfast, their perceptions of this breakfast menu are positive and should be reinforced by results once the menu reaches 1,000 stores by year-end, Smith said.

“Franchisees understand it’s a growing daypart that we haven’t participated in, and that it expands our ability to get into other dayparts, like 24-hour,” he said. “Some are skeptical, clearly, and that’s not unusual. It’s also why it’s our job to vet and prove that these ideas are accretive to sales and profits in the long term … and that’s what we think these 1,000 stores will show.”

Early next year, Wendy’s plans to start testing a premium upgrade of its chicken sandwiches in an effort similar to “Project Gold Hamburger,” which produced Dave’s Hot ’n Juicy Cheeseburgers.

Reignited growth in store

Wendy’s began testing its four prototype designs this quarter for a major remodeling program to start in 2012, officials said. The first two units of 10 to be built in five cities for 2011 opened in Columbus, Ohio, in the past few weeks, and sales already are up 50 percent at those locations, Smith said.

While the company does not expect that sales spike to last, it is nonetheless encouraged by the décor upgrades, which include larger windows, a more open kitchen, lounge seating and a “Wi-Fi” bar. Smith said the new designs would build on the success of new menu items to make Wendy’s locations more profitable and thus more viable in new U.S. markets.

“We know that the quality of our physical plant has a big impact on the overall experience for the consumer,” Smith said. “Over the past 18 months, we’ve revamped almost the entire menu, and with the roll-out of our new burger line, and next year the new chicken line, there’s hardly an area of the menu we haven’t improved significantly. Now is the time when upgrades to our buildings make sense.”

Expanding breakfast and picking up the pace of store remodels would be linchpins of the unit-count growth Wendy’s wants to realize in the United States, particularly in urban centers where its competitors have far more locations, Smith said.

“The contemporary designs and new menu will grow sales, and if you add breakfast on top of that, it gets us into an average unit volume that provides the return on investment that makes sense to develop new areas,” he said.

Wendy’s projects opening 20 U.S. company-owned stores in 2011, as well as 45 domestic franchised stores. Forty international locations are expected to open this year, and Wendy’s currently has commitments for 700 international restaurants, while seeking joint-venture opportunities in Brazil and China.

A major part of reigniting domestic growth, however, will be collaborative financing for Wendy’s franchise system in the form of subsidized loans for burger equipment and royalty abatements for early adopters of the breakfast platform, officials said. Wendy’s also will offer royalty reductions in the United States and lease guarantees in Canada as incentives to grow more stores.

“We need franchisees to participate with us in the test, so it’s only fair we assume some of the risk, because not every test works,” Smith said.

Chief financial officer Steve Hare added, “We don’t anticipate a significant impact to the P&L. There’s a high level of excitement around these programs, and funding availability is spotty, so we wanted to make sure financing is available to our franchisees.”

Dublin, Ohio-based Wendy’s operates or franchises more than 6,500 restaurants in the United States and 25 foreign countries.

Contact Mark Brandau at [email protected].
Follow him on Twitter: @Mark_from_NRN

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