Rangebound for Months, Wendy's Stock Looks for a Fast Break

Lately, Wendy's (NASDAQ:WEN) stock chart has been about as flat as one of its value menu hamburgers. Since advancing 42% in 2019, the fast food, er quick-service restaurant, has struggling to get a second wind in an evolving restaurant industry.

Certainly, subsiding pandemic headwinds would help Wendy's financial performance and share price, but there is more to the story. A rising debt burden and a changing competitive landscape may make keep Wendy's stock frosty for a while.

How were Wendy's 2020 Financial Results?

Wendy's 2020 results showed that operating conditions improved as the year progressed but are still far from good. For the full year revenue inched 1.2% higher to $1.73 billion. The result was respectable all things considered, but this is a company that had grown its top line at a 14% clip over the last five years. Earnings per share slipped 3.4% last year to $0.57 with COVID related expenses weighing.

More concerning than the sales and profit figures is Wendy's balance sheet. With the long-term debt-to-capital ratio now at 87% (80% including just long-term debt), Wendy's capital structure is significantly skewed to leverage which may make it more difficult for the company to receive additional funding if needed to get through the remainder of the pandemic. It also gives it less flexibility to pursue growth opportunities as the restaurant backdrop improves.

Despite the compromised financial position, Wendy's management decided to bump the quarterly dividend from seven cents to nine cents last month. This may not seem like such a bold move but given the lingering uncertainty of the pandemic and the company's shrunken cash position of $307 million, it may come back to haunt especially if the pandemic takes a turn for the worse.

 Has the Pandemic Forever Changed Fast Food?

In a sense, the pandemic has leveled the playing field in the restaurant game. Dining room closures and capacity restrictions have turned most businesses into take-out only. Whether it be curbside pickup or drive-through, seemingly everyone, quick service or not, has pivoted to a model of convenience.

This has in effect made most out-of-home dining options fast food places because they are all among the choices on popular delivery platforms like Uber Eats and Door Dash. In other words, it often takes just as long to receive an order from Wendy's as it does from the popular four-star American bistro down the street.

It also means Wendy's now has much more competition beyond its quick service brethren. Although the food quality, choices, and prices vary considerably, consumers in the post-pandemic economy may value convenience far less than before. This could especially be the case if the remote work theme has some permanence as widely anticipated. Fewer employees would be rushing around to get back to work in time. Convenience may be redefined from fast food to not having to leave the house.

 How Will Wendy's Differentiate Itself?

In addition to the usual competition from McDonald's and Burger King, Wendy's will have to battle rising input and labor costs on the other side of the pandemic. Not to mention that people may be more health-conscious and less apt to grab fast food in the post-pandemic world. So, given this mix of challenges how will Wendy's stand out from the crowd?

For starters, Wendy's will look to expand its footprint to give it access to more markets and customers. Last year approximately 150 locations were opened in spite of the economic environment.

A bigger determinant of Wendy's success over the next few years will be the performance of its digital sales channels. In 2020 digital sales more than doubled as loyalists took to the Wendy's app.

Last, Wendy's move into breakfast has proven to be an astute move given the boost to sales and higher margins in breakfast. Seven percent of sales came from breakfast last year. If it can continue to find success in the breakfast arena by introducing new products and promotions this could play a big role in leveling the McDonald's/Burger King playing field and fending off competition from the enclave of upstart burger-only joints.

Is Wendy's Stock a Buy?

Wendy's stock has hovered in the $20 to $25 range for the better part of the last 12 months. This has left shareholders with little to cash in on other than the modest quarterly dividend.

The Street's price targets issued over the last three months have been equally unexciting even for a QSR stock. The latest projections for Wendy's stock price range from $22 to $27.

Despite being down 7% this year, shares of Wendy's are hardly on the value menu at 30x forward earnings. In comparison, McDonald's and Restaurant Brands International are trading at 27x and 25x forward earnings, respectively. Shake Shack goes for 17x forward earnings.

To be fair a slight premium may be warranted given Wendy's above-average sales growth rate over the last five years and its higher net profit margin. It has however, lagged its peer group in terms of earnings growth over the last four quarters.

So, Wendy's price tag is not exorbitant either, and a holding pattern seems most appropriate here. With uncertain growth prospects in an uncertain restaurant industry, investors may be better served to put their money to work elsewhere.