Wendy's Faces Challenges: Will Breakfast Sales Boost Stock?

Wendy's (NASDAQ: WEN) is in the consumer discretionary sector and is underperforming the sector so far in 2024, with a total return of -10%. The Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) has returned -1%.

The company reported Q2 2024 financial results on August 1, 2024. Let's start by reviewing the business operations and then reviewing the earnings report. We'll then look at some information on what to watch around the company.

Wendy’s Operating Segments

Wendy’s business contains two main operating segments: Wendy’s U.S. and Wendy’s International. Wendy’s restaurants inside the U.S. comprise about 87% of the total. In 2023, international same-restaurant sales grew at more than twice the rate of U.S. locations.

As a fast-food business, Wendy’s restaurant sales are primarily generated through its drive-thru window. These sales made up 74% of revenue in 2023. That number is moving down, closer to the 66% level it was at prior to the COVID-19 pandemic, as customers return to eating inside the restaurant.

The company breaks down its revenue into three channels: sales, franchise royalties and fees, franchise rental income, and advertising. The bulk came from sales and franchise fees, accounting for 70% of total revenue.

Wendy’s Q2 Earnings and Comparison to McDonald's

Wendy’s missed slightly on adjusted earnings per share (EPS) at $0.27, compared to estimates of $0.28. This was a -3.5% surprise and a decline from $0.28 the previous year. Revenue came in 11% below expectations at $571 million and was up 1.6% from a year ago. It reaffirmed its full-year adjusted EPS guidance at a midpoint of $1.00, slightly above expectations.

Wendy’s posted global same-store sales growth of 0.8%. This figure can represent a better measure of operational success than overall sales growth as it strips out sales from new stores. New store sales are often higher initially as these locations penetrate new markets.

The figure feels anemic; however, it significantly outpaced that of its competitor McDonald's (NYSE: MCD). McDonald's reported earnings on July 29 and saw comparable sales fall 1%. McDonald's also saw a much more significant decline in its adjusted EPS of -11%.

Increased advertising revenue and franchise royalties bolstered revenues. A big negative is an approximate 200 basis point decline in Wendy’s operating margin, which fell to 17.4%. This was better than the 270 basis point drop at McDonald's. However, McDonald's has a vast advantage with a 45% operating margin.

Wendy’s might look undervalued compared to McDonald's when looking at its forward price-to-earnings ratio of 16.7, which sits 26% below McDonald's. However, McDonald’s superior margins and leverage position justify this. Wendy’s net debt-to-EBITDA ratio is 2.7 times higher than that of McDonald's after adjusting for capital expenditures. Wendy’s ratio sits at the 80th percentile of the U.S. consumer discretionary sector.

Wendy’s is committed to paying a $1 per share annual dividend in fiscal 2024. At its current price, the company has indicated a dividend yield of 5.9%. This number sits well above the 3% average of dividend-paying companies in its industry and even further above McDonald’s 2.4%.

Wendy’s Needs to Grow Its Profitable Breakfast Business

Wendy’s CEO Kirk Tanner believes that its breakfast meals are extremely important to the company's future. In the Q2 earnings call, Tanner noted breakfast meals as being “highly profitable," and the firm outperformed competitors in the space during the quarter. This profitability largely comes from the fact that breakfast orders usually come from the drive-thru window, which is more profitable than sit-down orders.

Currently, McDonald's is the dominant player in breakfast, controlling 35% of the market share. Wendy’s barely cracks the top 5, at 2%. Wendy’s currently makes around $3,000 per store per week on breakfast, and Tanner wants that number to double over the next two years.

Investors should track progress on Wendy's growth in the breakfast space and comments from Tanner and other executives about it. Achieving success here is key to evaluating management competency, as they are pushing hard in this area.

Wendy’s has seen recent success; visits to the restaurant in the morning jumped 9.3% from the previous year in Q1 2024. The success of Wendy’s Biggie Bag, the most popular fast-food value meal, should give investors confidence they can succeed.

Seven Wall Street analysts updated their price targets after the release. The average price target for those analysts is $18.78, implying an upside of 11%.

The article "Wendy's Faces Challenges: Will Breakfast Sales Boost Stock?" first appeared on MarketBeat.