Wendy's Serves Up Weak Results

The fast food chain's sales decline raises the prospect of more investor activism for change.
Author:
Publish date:

Updated from 10:49 a.m. EST

After

Wendy's

(WEN) - Get Report

fourth-quarter results put the focus back on the company's deteriorating fundamentals, investors might have had newfound reason to believe that activist hedge funds would gain traction in their bid to gut the struggling company.

Wendy's reported Friday that its sales continued to fall in the fourth quarter. Those results capped a year when its shares rose 42% in spite of the fast food chain's worst sales performance in 18 years. The shares rose as much as 2% Friday but recently leveled to a gain of 3 cents to $58.42.

At a meeting with Wall Street analysts on Monday, Wendy's will attempt to sell investors on a plan to revitalize its brand, but the company's management might be under more pressure to bow to the wishes of its most vocal shareholders.

Wendy's has seen better days. It has been short of an effective marketing message since its founder and longtime public face, Dave Thomas, died in 2002. Last year, a Nevada couple planted a human finger in a bowl of Wendy's chili in a much-publicized attempt to bilk the company in court. The couple eventually pled guilty to fraud charges but Wendy's still lost millions in sales, and dozens of employees at its franchises were laid off as a result.

Meanwhile, fast-food competitors like

McDonald's

(MCD) - Get Report

,

Yum! Brands

(YUM) - Get Report

and

Burger King

have moved in on Wendy's turf.

"We think that a competitive headwind has nearly stopped Wendy's in its tracks," said Morningstar analyst Carl Sibilski in a recent research report.

In the fourth quarter, Wendy's total sales dipped to $977 million for the period from last year's $978 million and same-store sales, or sales at stores open at least a year, at its namesake chain declined. For all of 2005, the company's same-store sales dropped 3.7% -- its first annual decline in 18 years.

Prudential Equity Group analyst Larry Miller estimated in a research note that same-store sales at the Wendy's chain declined 2% in January, a month when most restaurant chains enjoyed healthy sales gains.

On the profit side, the Dublin, Ohio-based fast food giant recorded net income of $30 million, or 25 cents a share, for the fourth quarter. That marked a reversal from last year's fourth quarter, when it reported a loss of $141.4 million, or $1.25 a share, as its results were weighed down by a $190 million impairment charge.

This year's fourth-quarter profit was hurt by a bevy of charges resulting from Wendy's restructuring initiatives. The results include $55.4 million in charges for store closures, $36.1 million in goodwill impairment, $8.1 million in stock compensation expense and $3.2 million related to the planned spinoff of its Tim Hortons division.

Excluding the charges, Miller said Wendy's earnings amounted to 44 cents a share. That figure missed Wall Street's projection for earnings of 47 cents a share, according to analysts' average estimate reported by Thomson First Call.

In general, Wendy's fundamentals have been lacking. Its company-owned stores have recorded average profit margins of about 10%, compared with the industry standard of about 20%. Also, the company has spent $1.3 billion on the business over the last six years while its operating income has declined. Its five-year president and chief operating officer, Tom Mueller, left the company last fall. Investors have attributed his sudden departure with the company's lackluster results.

Despite all the negatives, Wendy's continued to appeal to investors with the fruits of its restructurings and a number of shareholder-friendly measures taken at the prodding of an activist hedge fund.

In July, the company bowed under pressure from Pershing Square Capital, a hedge fund run by Bill Ackman -- the investor who recently made headlines with his call for structural changes at McDonald's. Wendy's agreed to raise its dividend, expand its share repurchasing plan, sell off underperforming real estate and spin off its Tim Hortons doughnut chain, a popular brand in Canada, in an initial public offering.

As a result of the moves, Wendy's benefited from a pretax gain of $60.9 million related to the sale of 166 properties during the quarter. Most of the cash from the sale likely will be returned to shareholders. Meanwhile, after the recent McDonald's spinoff,

Chipotle Mexican Grill

(CMG) - Get Report

, scored last week with the biggest opening-day gain for a U.S. IPO since late 2000, investors are enthusiastic about plans for Tim Hortons.

"Tim Hortons is likely to fetch a fat premium as its many fanatical Canadian customers will likely snap up the shares, creating something of a euphoric effect for the stock," Sibilski said. "We think the plans make sense because Wendy's can generate plenty of cash to make shareholders happy, but probably not enough to mount a prolonged and fierce competitive fight against well-heeled rivals."

At least one investor doesn't think Wendy's plans for cash generation go far enough. Nelson Peltz, the billionaire investor who turned around the Snapple and Arby's brands, recently revealed that his fund, Trian, acquired about 5.5% of Wendy's through stock and options. Peltz called for a complete spinoff of Tim Hortons, among other moves, in a regulatory filing in December, and he is expected to wage an ongoing battle if his proposals meet resistance.

In the filing, Peltz called the company's plans for a partial spinoff of Tim Hortons "an attempt to avoid shining the spotlight on the poor financial performance of Wendy's business" that "would perpetuate a highly inefficient and costly conglomerate structure." Trian estimates that Wendy's shares could be worth between $77 and $89 if its plans are implemented.

Wendy's chief executive, John Schuessler, is expected to rebuff Peltz's proposal, since its argument rests on the idea that the CEO's leadership has been ineffective. Still, Trian could gain leverage from widespread shareholder support, since much of the company's outstanding shares are held by hedge funds that are sympathetic to its cause.

"Management intends to return the cash to shareholders through stock buybacks and dividends, leaving lots of time to focus on the Wendy's brand and perhaps even position itself to be acquired later on," Sibilski said.