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Wendy's/Arby's: Add to Your Watch List

Wendy's/Arby's Group is a turnaround stock with solid prospects. As the market struggles, watch this name, especially on pullbacks.
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BOSTON (TheStreet) -- Restaurant owner and franchisor Wendy's/Arby's Group (WEN) - Get Report gets no love from investors, but the company delivered solid quarterly numbers, exceeding analysts' earnings forecast by 25% and matching their sales estimates.

The stock has fallen 25% from a 52-week high on April 26, but considering the volatility of markets in recent weeks, Wendy's/Arby's Group appears to be a comparatively safe investment at its current price.

The company's second-quarter net income dropped 28% to $11 million, but earnings per share remained steady at 3 cents. The gross margin hovered at 25%, but the operating margin extended from 7.5% to 8.6%. Wendy's comparable store sales declined 1.7% while Arby's registered a drop of 7.4%. However, revenue fell just 3.9% to $877 million. Operating profit was boosted by a 3.9% decrease in the cost of sales and a 14% drop in general and administrative expenses. Although respective business performance was lackluster, there is reason for optimism.

The company has ambitious international expansion plans. Since Wendy's and Arby's merged in 2008, 45 restaurants have opened outside of North America. And management has signed development agreements for 400 new international locations over the next 10 years. Franchise sales comprised just 12% of quarterly sales, so the international franchise arena is a preferred growth venue. The balance sheet stores $508 million of cash and $1.6 billion of debt, equaling a quick ratio of 1.4 and a debt-to-equity ratio of 0.7.

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Wendy's/Arby's stock has dropped 36% a year, on average, since 2007. In 2010, it has fallen 11%, more than the S&P 500, which is down 4%. It commands a forward earnings multiple of 23, equal to competitors' stocks, but greater than the S&P 500 average. But its book value multiple of 0.8, sales multiple of 0.5 and cash flow multiple of 7 reflect discounts of 86%, 81% and 43% to restaurant industry averages.

Quarterly return on assets widened to 0.2% and return on equity rose to 0.3%, lagging the industry average of 27%. Both measures were negative in the year-earlier quarter.

Analysts' opinions of the company vary. Six, or 38%, advise purchasing its shares, nine recommend holding and one advocates selling them. A median target of $5.18 suggests a potential return of 25%.

CL King

expects the stock to gain 68% to $7.

Oppenheimer

predicts a rise of 27% to $5.30.

Deutsche Bank

(DB) - Get Report

projects a climb of 26% to $5.25.

Wendy's receives an aggregate analyst rating of 3.6 from

Bloomberg

, exceeding its peer average of 3.4.

Barclays

(BCS) - Get Report

, which rates the stock "overweight", is "neutral" on the sector. Barclays says Wendy's/Arby's shares have solid support at the $4 level, despite a recent reduction in management's 2010 forecast. The bank just lowered its price target on the stock from $6 to $5, suggesting 20% share price growth. Now is the time to watch the shares. Food costs are expected to rise in the second half of 2010, possibly hurting the company's financial performance and stock price, allowing investors to buy on the cheap.

Barclays cites organic growth investments, specifically a 200 unit remodeling project for both restaurant brands, expanded breakfast offerings and the international push, as catalysts for medium-term outperformance. A remaining $80 million in the share repurchase program and a steady 1.4% dividend yield are also assuring signs. Wendy's is rolling out breakfast offerings in Pittsburgh, Kansas City and Phoenix test markets in the third quarter. It has also added a new lineup of premium-priced salads.

A new pricing model with greater disparity between low- and high-priced items is expected to boost overall check and comparable sales in 2011. In the midst of ongoing consumer retrenchment, Barclays recommends overweighting fast-food names with rebound potential. Aside from Wendy's, it rates

Dow Jones Industrial Average

component

McDonald's

(MCD) - Get Report

and

Burger King Holdings

(BKC)

"overweight." Barclays is also comparatively bullish on

Brinker International

(EAT) - Get Report

and

Darden Restaurants

(DRI) - Get Report

.

-- Reported by Jake Lynch in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.