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The Wendy's Company ((WEN - Analyst Report)), one of the leading quick-service restaurant companies, is slated to release its third quarter 2011 results on Wednesday, November 9, before the market opens. The current Zacks Consensus Estimate for the third quarter is pegged at 4 cents, representing an annualized negative growth of 18.7%.

With respect to earnings surprises, Wendy’s has missed the Zacks Consensus Estimate twice and has outperformed and matched it once in the last four quarters. The average earnings surprise was a negative 13.9%. This implies that the company has missed the Zacks Consensus Estimate by the same magnitude over the last four quarters.

Last Quarter Recap

During the second quarter 2011, Wendy’s posted adjusted earnings of approximately 5 cents per share, in line with the Zacks Consensus Estimate. However, on a reported basis, earnings were 3 cents per share compared with 2 cents in the year-ago quarter.

Total revenue in the reported quarter grew 2.5% year over year to $622.5 million in the quarter, mainly on the back of an upside in company-operated restaurants (up 3.9%) and franchise revenues (up 4.3%), partially offset by lower bakery and kids’ meal promotion items sold to franchisees (down 29.0%). Wendy’s closed positive transactions during the quarter aided by menu improvements as well as brand repositioning.

Wendy's North American same-restaurant sales (comps) increased 2.3% driven by an identical gain at both franchised restaurants and company-operated outlets. This marked the company’s best sales performance since the fourth quarter of 2008.

Company-operated adjusted restaurant margin contracted 250 basis points (bps) to 13.9% in the reported quarter due to a 170-bp rise in food and paper costs, 50-bp spike in occupancy, advertising and other operating costs and a 30-bp upside in labor costs.

Outlook

For 2011, Wendy’s expects same-store sales at North American company-operated restaurants to be up 1% to 3% year over year.

Wendy’s reiterated its adjusted EBITDA guidance range of $330–$340 million for the full year. However, the company lowered its company-operated restaurant margin expectation to the range of down 50–100 bps from the prior level of flat to slightly negative in 2011, due to higher commodity costs arising from significant increases in beef cost.

Wendy’s also plans to open 20 company-operated and 45 franchised stores in the domestic market and 40 franchised restaurants in the international market in 2011.

Estimate Revision Trend

Estimates for the upcoming quarter remained unchanged over the last 90 days, implying that the analysts are maintaining their outlook following the second quarter earnings release. The current Zacks Consensus Estimate is pegged at 15 cents for 2011 (reflecting a year-over-year growth of 4.02%) and 22 cents for 2012 (reflecting a year-over-year growth of 51.5%).

Agreement of Estimate Revisions

In the last 30 days, two out of 15 analysts have trimmed the estimates for the third quarter of 2011 and three out of 16 analysts have slashed the estimates for fiscal 2012. None of the analysts revised the estimates upward. For 2011, one analyst has raised the estimate and one has slashed the same, thus providing no clear directional movement.

None of the analysts made any estimate revision over the last 7 days, implying the absence of any near-term catalyst.

Some of the analysts remain skeptical due to weak economic conditions resulting in lower consumer spending as well as commodity inflation.

Magnitude of Estimate Revisions

Over the past 90 days, Wendy's estimates for the upcoming quarter did not budge. Therefore, the analysts expect the company to report in line.

The Zacks Consensus Estimate for 2011 inched up by a penny to 15 cents and fell by a penny to 22 cents for 2012 in the last 30 days.

Our Take

We expect the company’s revenue and margin to remain under pressure in the third quarter due to prevailing uncertain economic conditions, affecting consumers’ disposable income and commodity cost pressure.

Wendy's has outlined a multi-year turnaround plan to improve restaurant operating margins, reinvigorate brands, revitalize comparable store sales and expand internationally. The company is also concentrating on enhancing shareholder value through share repurchases and dividend distribution.  

The sale of Arby’s chain to help focus on Wendy’s solely as well as introduction of a new breakfast menu across 1000 stores by year-end also indicate growth potential. However, Wendy’s turnaround is in its initial stage.

Moreover, an uncertain economy with a high unemployment rate and faltering consumer confidence along with high commodity costs as well as heightened competition will likely restrain the company’s growth in the near term.

Accordingly, we have a Zacks #3 Rank, (short-term Hold rating). We are also maintaining our long-term Neutral recommendation on the stock.

One of Wendy's primary competitors, Kona Grill Inc. ((KONA - Snapshot Report)) reported third quarter 2011 adjusted earnings of 8 cents per share, which beat the Zacks Consensus Estimate by 2 cents and improved substantially from the year-ago loss of 3 cents.

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