Wendy’s/Arby’s 1Q09 Results Mixed

Wendy's Adapts with Value Offerings, Arby's Lags Lean Times

The sinking economy necessitates that restaurants adapt to survive. First quarter financial results at Wendy's/Arby's Group Inc. (WEN - Analyst Report) indicate Wendy's is adapting well to the lean times, attracting cash-squeezed consumers with a "Value Trio" of 99-cent sandwiches, while Arby's $5.95 bundling value packages is driving them to cheaper fare at McDonald's (MCD - Analyst Report), Taco Bell -- a Yum Brands Inc. (YUM - Analyst Report) concept, and Jack in the Box Inc. (JACK - Snapshot Report).

Wendy's/Arby's Group, formed in September through the merger of Arby's parent, Triarc, and Wendy's, reported that 1Q09 system-wide same-store sales at its Wendy's fast-food hamburger chain rose 1.0%, but fell 8.7% at the pricier Arby's roast beef take-out chain. Wendy's comps would have been stronger, but 300 of its units stopped serving breakfast.

Excluding one-time charges, 1Q09 EPS was $0.01, missing our estimate of $0.04 and the consensus of $0.03. Impairment charges at Arby's and other non-recurring charges totaling $0.03 per share after-tax pushed EPS to a loss of $0.02 for 1Q09.

Adjusted EBITDA grew 8% sequentially to $80 million in 1Q09, and the EBITDA margin expanded 110 basis points to 10.4% from 9.3% in 4Q08, as management continues to wring G&A overlap from the system post-merger and squeeze labor savings at Wendy's through a new scheduling system.

Wendy's appears on track to continue increasing same-store sales through menu innovation of both premium and value products, and by expanding its retooled breakfast menu into new markets. Arby's, in contrast, appears set to continue losing value-conscious customers to competitors. Although Arby's continues to launch premium products, recently introducing a "Roastburger" line of roast beef sandwiches, it has not included any sub-$1.50 menu offerings to compete with the value menus of major fast food chains.

Margins at Wendy's company-owned stores have severely lagged its peers for years and improving them will be a key catalyst for stock price improvement. Management is targeting a 160- to 180-basis point restaurant margin increase at Wendy's for 2009, from expected improvements in food, labor and restaurant operating expenses.

While we think this goal is viable -- Wendy's franchises have higher margins than its company-owned stores due to more frequent price hikes -- it won't be without significant challenges. Wendy's fresh, never frozen, all-beef hamburgers are more
expensive to produce, at a time when commodity prices are rising and value pricing is imperative to sales.

Restaurant margins at Arby's, which were healthy when the economy was better, sank to 14.2% in 1Q09, from 14.6% in 4Q08 and 17.1% in 1Q09 on operating deleverage as company-operated same-store sales fell 8.0% and commodity input prices rose. Arby's high average check of $7.50 continues to drive cash-strapped diners to cheaper competitors.

Stabilizing Arby's same-store sales could be another key catalyst for WEN stock price appreciation. In the meantime, management said it will slow new store growth, slashing capital spending, particularly at Arby's, while it improves profitability.

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