Last week, fast food chain Wendy’s (WEN) announced it would be buying back $1.4 billion in WEN stock by the end of 2016. And while most investors love when companies give back to the shareholders, this looks like just another tactic by Wendy’s management to help boost earnings per share.
Wendy’s had already agreed to buy back $211 million worth of WEN stock from its largest shareholder, Trian Fund Management, which is looking to reduce its stake in the company from 25% to somewhere in the 20% to 17% range.
Last week’s announcement includes the $211 million that WEN will buy back from Trian, which is headed by billionaire Nelson Peltz.
WEN stock popped by 3% with last week’s announcement and its approaching its all-time high of $11.71.
Comparing WEN and CMG
The third-largest burger chain in the U.S., Wendy’s has been battling falling revenue in recent years. In 2012, WEN reported revenue of $2.5 billion, but by 2014 that figure was just $2 billion.
Surprisingly, diluted earnings per share excluding extraordinary items rose from 1 cent in 2012 to 32 cents in 2014. Even diluted normalized earnings per share jumped from 24 cents in 2012 to 29 cents in 2014. How can revenue fall but earnings per share move higher?
In that case, WEN was selling company-owned restaurants in an effort to help lower costs and improve margins. In 2014, the company had nearly 4,900 restaurants and owned most of them, with only 855 being franchised. In February — as it released another disappointing earnings report — Wendy’s announced plans to sell another 500 stores to franchisees and stated a goal of just owning 5% of its locations.
Franchised restaurants give companies such as WEN a more predictable cash flow and better margins. But compare that strategy to quick serve restaurant industry leader Chipotle Mexican Grill (CMG), which owns every one of its locations because when the company attempted to franchise out locations, it realized it lost control of quality and consistency of its product.
Chipotle not only stopped franchising, but bought back all the stores it had sold.
While Chipotle and Wendy’s is certainly comparing burgers to burritos, the fact that WEN is selling the majority of its locations should tell investors something about management and its possible lack of long-term vision.
WEN’s Buyback Plan
At today’s share price of $11.27, WEN would be able to repurchase more than 124 million shares of WEN stock under its recently announced $1.4 billion buyback plan. The most recent quarterly report tells us that WEN has 363 million shares outstanding and just 272 million shares in float.
So the buyback could nearly cut the float in half and reduce the shares outstanding by one third. With that amount of share reduction, earnings per share should go up by at least the amount that is being taken away — about 34%.
But, management only expects EPS growth of 20% by 2018, a full year after the buyback program is expected to end. As for 2016, WEN management has stated that EPS growth will be in the high single digits. So what is happening to the extra 14%? Are sales still falling? Is the company still struggling to grow EPS organically?
I must admit that it is unlikely WEN will buy back 124 million shares, just because as shares begin to come off the market, the lower supply will likely push the price higher. So, let us assume that Wendy’s only buys back 20% of its outstanding shares as opposed to 34%. That would mean 20% EPS growth in 2018 would solely be due to the share buyback plan and not improved company performance.
To me, that would mean in 2018 the company would again need to financially engineer EPS growth in some way in order to keep the ball moving.
And in 2018, that may be difficult since all but 5% of stores would be franchised and WEN will likely have something to the tune of $2.8 billion in debt, adding the company’s current debt of $1.4 billion and the money used for the share buyback of $1.4 billion.
So in 2018, investors in WEN stock could have a company with no EPS growth, $2.4 billion in debt and a nearly completely franchised business model. This sounds like a long-term shareholders’ nightmare.
But, short-term investors could take a trip on the WEN stock as the buyback itself will likely move the stock price higher, assuming there are no other shoes to drop.
As of this writing, Matt Thalman did not hold positions in the aforementioned securities. Follow him on Twitter at @mthalman5513.
