Wendy's Stock Bid Up In Anticipation Of 2018 Growth

Wendy’s (WEN) caught our attention as the stock has gotten some big bids in recent trading sessions. Take a look at the action in the last week:

Source: Yahoo Finance

So, what is going on here? We are somewhat surprised by the action as the company is having some performance issues, but we believe 2018 will see improvement and the Street is betting on this occurring. In this column, we will discuss some of the key issues plaguing the company, as well as discuss our expectations for 2018.

Sales fall, but store count declined

Sales were down very slightly versus last year in the fourth quarter. This was enough to spook investors this week. Total revenues were $309.2 million in the fourth quarter of 2017, compared to $309.9 million in the fourth quarter of 2016:

Source: SEC filings

Here is one positive to keep in mind. Compared to last year, there were 90 fewer company-operated restaurants. So, this had the impact of fewer sales at company-operated restaurants, but this was in part offset by higher franchise royalty revenue, fees and rental income. What is really problematic is the comparable sales figure, which came in at 1.2%, which was well below the greater than 2% we were expecting. This also led to issues with margins.

Margins disappoint

Despite the fact that sales were down only slightly even though there were fewer company owned stores, expenses caught up with the company and weighed on margins. This is not good enough. Company-operated restaurant margin was 17.5% compared to 18.8 percent in the fourth quarter of 2016. The 130 basis-point decrease was primarily the result of higher commodity and labor costs, partially offset by lower other operating costs. But this weighed on profit

Operating profit falls, but earnings impress thanks to tax changes

Operating profit was $66.6 million, compared to $79.2 million last year. The 15.9% decrease resulted primarily from a year-over-year decrease in gains from the company's system optimization initiative, as well as higher commodity costs. However, tax benefits helped net income.

Net income was $159.3 million, compared to net income of $28.9 million in the fourth quarter of 2016. This massive 451.3% resulted primarily from a decrease in the effective tax rate due to the Tax Cuts and Jobs Act of 2017. As such, reported diluted earnings per share were $0.64 in the fourth quarter of 2017, compared to $0.11 in the fourth quarter of 2016. When we make adjustments, adjusted earnings per share were $0.11 compared to $0.08 in the fourth quarter of 2016.

2018 projections

Despite a poor end to 2017, we anticipate that comparable sales will return to plus 2% growth we have expected for the company. We are targeting North America same-restaurant sales growth of approximately 2.0 to 3.0 percent.  

We do have continued concerns over commodity costs, and expect them to rise again in 2018 by 2%, while labor costs could rise mid-single-digits. We will be closely watching margins out of the company but thanks to these rising costs we think margins will come in below 18 percent.

Factoring in sales growth in the single-digits, and an improved tax rate, we will be looking for adjusted earnings per share to come in around $0.53 to $0.57.