Wendy’s Case Study
The very nature of finance is that it cannot be profitable unless it is significantly leveraged… and as long as there is debt, there can be failure and contagion.
Alan greenspan
Wendy’s (WEN) has a total of 7,240 restaurants worldwide. Of these, 6,825 are franchised locations, while 415 are company-operated restaurants. So, the vast majority of restaurants operate under a license from the parent company. This model has been crucial to Wendy’s growth and expansion strategy, allowing the company to leverage the entrepreneurial spirit and grow into a global franchise powerhouse.
Despite Wendy’s strengths, there are several factors that contribute to consumers avoiding the chain. To begin, market saturation and accessibility play a significant role in consumer preference. McDonald’s, for example, has more than twice of Wendy’s locations in the United States, providing greater convenience and visibility for consumers. This extensive network allows McDonald’s to maintain stronger brand recognition and customer loyalty through sheer presence. Wendy’s has also faced backlash for embracing surge pricing habits which spike prices during busy hours.
As of August 1, 2024 the company reported Q2 results which were disappointing. Per Zacks Equity Research, EPS was 27 cents per share vs consensus estimates of 28 cents which match the prior year. Sales growth was at the low end at just 1.6% year-over-year at $570 million, below expectations of $577 million. Net income was $54.6M down 8.4% from the previous year.
| Stock Price | P/E | 200 Day M/A | Div. Yield | Div. Rate | Payout Ratio | Return on Assets | Rev. Grwth. |
| $16.91 | 17.28x | 18.32 | 5.90% | $1 | 102% | 4.43% | 1.60% |
| Earnings Grwth. | FCF | Interest Exp. | EPS | D/S | DEM | Net Margin |
| -8.40% | $215M | $120M | $0.98 | $20.18 | 20.17x | 9.20% |
It is also important to note that the company has been losing market share in recent years to competitors like McDonald’s and Burger King. As of early August, Wendy’s market position has shown signs of weakness, with its estimated market share declining from 2.25% to 2.22% over the past year. This situation underscores the challenges Wendy’s faces in competing with larger, more established rivals and highlights the need for the company to find innovative ways to accelerate its growth and recapture market share.
Wendy’s is trading below its 200 day moving average of $18.32. Stocks can crash from weak positions. Beyond speculation, however, let’s look at the facts. Wendy’s has an earnings per share (EPS) of $0.98 and debt per share (DPS) of $20.18. The company’s interest expense was $30 million in the first quarter and $120 million last year. The dividend is $1 with a forecasted EPS growth rate of 8.7%. Though WEN has $215 million in free cash flow, 50% of it is eaten up by the interest expense. Moreover, the dividend payout exceeds earnings by 102%. So, the company’s dividend and interest expense consumes 150% of generated cash. Adding an additional 8% to the bottom line will change little to nothing. With the current trend in restaurant earnings alongside the macro consumer outlook, I do not believe Wendy’s will grow earnings by this amount. Cash on hand has gone from $746 million at the end of 2022, to $516 million at the end of 2023, to $465 million as of June 20, 2024. During this same period their debt to equity has gone from a bad 919% to a scary 1,500%.
So where does that leave Wendy’s? The obvious response will be a dividend cut. A 50% cut to $0.50 per share + interest expense puts the cash flow and earnings at even, leaving no cash earnings for reinvestment into the business. What will that do to the stock? Given that this potential announcement will likely come combined with other bad news to shareholders, I would expect a rapid drop in the stock price. Furthermore, Wendy’s debt to earnings multiple (DEM) is 20.17x vs McDonald’s DEM of 6.34x. I question why an investor would consider taking a position in a company where 50% of its future cash earnings are committed to debt, with no indication of a rise in overall cash flow. Lastly, McDonald’s dividend yield is a safe 2.31% with a 57% payout. At a 57% payout ratio Wendy’s would still be using more cash for dividend and interest than it generates. So how far might this dividend get cut, nobody knows.
On the narrative front, let’s be honest: it’s Wendy’s. Their real estate has always been 2nd class compared to McDonald’s. This is evident from Wendy’s average unit volume of $2,000,000 compared to McDonald’s of $3,600,000. With a downturn in consumer activity, Wendy’s has zero cushion to maintain a respectable dividend and meet the interest expense.
The US is facing the largest downward jobs report revision since 2009 when the country was in the midst of the Great Recession. In fact, the US recently had a decline in over 800,000 jobs, sparking fears of a near recession. As the thought of economic downturn lingers, it is not the time to take on restaurant franchises with high debt. Moreover, Wendy’s alarmingly high payout ratio (almost double that of McDonald’s) forces the company to pay out more in dividends than it earns. Wendy’s has underperformed same-store sales growth in comparison to direct competitors, and its financial obligations are simply unsustainable.
While Wendy’s franchising model has facilitated its global expansion, the company faces significant challenges including market saturation, fierce competition, high debt levels, and an unsustainable dividend policy. It seems that Wendy’s is a risky investment proposition in the contemporary economic climate, and investors should sell their position.
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