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StockTalk
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TMF Interview With Wendy's International V.P. of Investor Relations John Barker
February 25, 1999
With Brian Graney (TMF Panic)
Started in 1969 by a high school drop-out named Dave Thomas, Wendy's International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WEN)") else Response.Write("(NYSE: WEN)") end if %> has become the third-largest chain of quick-service restaurants in the world. The company operates or franchises a total of 7,000 restaurants around the globe, generating $6.5 billion in system-wide sales. In 1995, the company acquired Tim Hortons, which operates 1,667 coffee and baked goods shops in the U.S. and Canada. We talked with Wendy's V.P. of Investor Relations John Barker about the Tim Hortons acquisition, current conditions in the fast food business, and Wendy's ongoing efforts to boost profitability.
TMF: I was wondering how you think the Tim Hortons concept is working in the U.S. Will it really ever work as well as it did in Canada?
Barker: We completed the acquisition of Tim Hortons in December 1995. Before the acquisition, Tim's was a terrific chain with about 1,200 stores up in Canada. They had been growing sales better than 20% system-wide -- and 20% on the pretax income line -- so we were very happy with pulling the two companies together.
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"As we take a look at our earnings capacity going forward, we think we're a low- to mid-teens grower on an operating earnings basis. We think of that as very achievable."
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Just as a little background, Tim Hortons is the largest coffee and donuts chain in North America. They have about 60% of the coffee and donut market up in Canada so we're pretty excited about bringing the two chains together. Since the time of the acquisition, we've added another 300 plus stores in Canada and their performance in Canada continues to run like right before we purchased it. In fact, their same store sales are up about 25% in the last three years -- which in this business is terrific.
We started to add some restaurants here in the States. They had a few units up in Buffalo before the acquisition so they started with Buffalo and we added units in Detroit, the Michigan areas, and Columbus, Ohio and in central Ohio. Today we have about 100 units in the States altogether. And our hope is that much like the way Tim's grew up in Canada, it will grow up here in the States. And that is, if you run the business well, you focus on operations, you establish the brand and you get to this investment stage, you get to the point where it's profitable. Certainly, we think that's going to happen.
TMF: Is this company treated as a separate entity or is there a possibility that it might be folded into Wendy's operations, maybe as a breakfast menu for Wendy's?
Barker: As a breakfast menu inside of Wendy's, that's not the priority. We do have combination units, where we take a full-sized Wendy's and a full-sized Tim's and put it basically in the same building. These are units that we've built from scratch. They're about 5000 square feet as opposed to the typical Wendy's, which would be 3000 square feet. A typical full-sized Tim Hortons would be about 3000 square feet. With these combos we put them together under one roof and there they do help each other out. Tim's does about 60% of it's business before 10:00 and Wendy's doesn't even open until 10:30, so you then get the benefit of breakfast and then different day parts out of the same building. And we have about 70 of those in Canada. Those do very well.
TMF: Is your company going to grow through other acquisitions down the road? If so, what type of restaurant company would really be the best candidate for an acquisition from Wendy's point of view.
Barker: Acquiring another branch, again, is not the highest priority. We've been public for over 20 years. Dave founded the company in 1969 and the only acquisition we've done of any size of another concept is Tim Hortons, so it's not something that's of the highest priority. We would be more interested in acquisitions of competing concepts for conversion to Wendy's or Tim Hortons, and we've done a lot of that in the last several years. We've acquired several units from Hardees, Roy Rogers up in New York, Rax Roast Beef here in central Ohio. We've done that with the intention of converting them to Wendy's or Tim Horton's and we've since done that. That's a higher priority for us.
TMF: The company's really been focused on increasing shareholder returns, especially through return on invested capital (ROIC) performance. That's really music to our ears, since that's one of our favorite metrics that we use to value companies. Can you tell us about Wendy's plans for improving ROIC this year and down the road?
Barker: Sure. We really started by taking a long look at our ROIC levels relative to several base indices. We took a look at consumer staples and we looked at companies at certain market capitalization sizes and compared us. And we also looked at other restaurant companies -- the restaurant companies that say had a $1 billion market cap and higher. We did an analysis of all of those companies and did an analysis obviously on Wendy's ROIC. And we came to this conclusion that it was unacceptable. We had some room to improve, so we embarked on several strategies to improve it.
The goal was to take it up about 200 basis points from a level of 9.4%. You know, you can get to different ROIC numbers based on what sort of analysis you do, what inputs you use. But for our purposes, we were at 9.4% at the beginning of this initiative. We compared ourselves to 10 or 12 peers and we were at the bottom third of those restaurant peers. So we said to ourselves, "Let's raise this by 200 basis points and let's move ourselves into the top third of these restaurant peers." These were other companies like Outback Steakhouse <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: OSSI)") else Response.Write("(Nasdaq: OSSI)") end if %>, Applebee's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APPB)") else Response.Write("(Nasdaq: APPB)") end if %>, Bob Evans <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BOBE)") else Response.Write("(Nasdaq: BOBE)") end if %>, McDonald's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MCD)") else Response.Write("(NYSE: MCD)") end if %>, Carl's Jr. [owned by CKE Restaurants <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CKR)") else Response.Write("(NYSE: CKR)") end if %>] -- those kinds of companies, and we wanted to move into the top third of that.
The general goals were to monetize anything on the balance sheet that we thought was underperforming. Take cash from the balance sheet that we weren't going to use for any particular thing [which was] generating say a 5% return and pile that into a share repurchase program. And then the last thing was to improve profits on existing restaurants. What all that really meant was looking on the balance sheet and saying "What do we do with underperforming stores?" Let's either close or refranchise those. We've done that -- about 80 of those. We repurchased in 1998 $211 million worth of common stock and we continue to repurchase stock now.
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"We don't discount our products ever, and we play a hard quality game. Our products are typically at the other end of the quality spectrum and customers know that."
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And we worked other things like our notes receivable portfolio, our lease portfolio -- really analyzing anything that was earning less than our cost of capital. And if it is, we're working to monetize that, generate cash, and use that for further share repurchase or new unit development. And the reason we do that is our new units generate somewhere around 2% to 3%, sometimes 4% higher than our cost of capital.
TMF: Assuming the 11% ROIC down the road, what's going to be the spread between that figure and your overall cost of capital?
Barker: Well, our cost of capital we think is somewhere in the 9% to 9.5% range. So if we move up to about 11%, certainly then there's a pretty nice spread there for the first part of that program. And we will continue to take a look at items on the balance sheet, anything that we can continue to work on -- things like margins, focusing capital more specifically in the future on the highest returning parts of the business, potential acquisitions -- and that will be sort of a never-ending process.
TMF: How do you keep earnings growth going in a company like Wendy's, which is kind of operating in what many would consider a fully mature industry?
Barker: Well, you know, it appears at times to be fully mature. It used to be that the business capacity [in terms of] number of restaurants was growing faster than demand. And really in late 1997 and through 1998 we saw the major companies like McDonald's and others start to slowdown the number of new units tremendously. What we've seen for the first time here in 1998 is that demand is catching up to capacity. And that is basically just taking a look at restaurant sales, the portion going to quick service restaurants and taking a look at new units that are being generated within the business.
McDonald's just a few years ago was adding 1000 plus units, Boston Chicken <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BOSTQ)") else Response.Write("(Nasdaq: BOSTQ)") end if %> was adding hundreds, Burger King [owned by Diageo PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DEO)") else Response.Write("(NYSE: DEO)") end if %>] was adding hundreds, we were adding hundreds, and there were just more restaurants opening than demand. And that has come back tremendously. Boston Chicken is in Chapter 11, Tricon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: YUM)") else Response.Write("(NYSE: YUM)") end if %> is essentially fixing their system and not adding new units, and McDonald's has dropped their added development numbers down by the hundreds. So, we're seeing a much healthier picture for the business. And as we take a look at our earnings capacity going forward, we think we're a low- to mid-teens grower on an operating earnings basis. We think of that as very achievable.
TMF: You don't really see a saturation point affecting the company in the near term?
Barker: Well, if you take a look at Wendy's in the United States, we have a restaurant for every 63,000 people. We have markets like Columbus, Ohio, where we have restaurants for about every 15,000 to 16,000 people. Columbus is where Dave founded the first unit in 1969. And here we have some of our highest average per store sales in the entire system. So we believe we have a long way to go in penetrating many of the markets. And one of the reasons is that when we go into markets where there already may be a McDonalds and some of the other competitors, Wendy's has this certain niche that allows us to dent it very well -- even if there are competitors there -- because we tend to play in the non-discounting game. We don't discount our products ever, and we play a hard quality game. Our products are typically at the other end of the quality spectrum and customers know that.
TMF: You talk about the discounts and it almost seems like a discount with your Super Value Menu and your $0.99 pricing point for many of your items. How profitable is that strategy? And separately, how has the proliferation of sandwich, drink, and fries combination meals affected the industry's dynamics?
Barker: Let's take the first one. The Super Value Menu is our form of discounting, although we don't discount it because it's been the same price, the same items now for nine years, going on it's 10th year. And those are a number of items that haven't changed. That's the junior burgers, things like baked potato that none of our competitors really have, chili and side salads. It's a number of things that people can count on every day at $0.99. We never change the prices so it's not a discount, it's just a value. So we think it allows us to play with the very price-conscious customers without having to take what we would call our core menu or anything on the premium side and discount it on an ongoing basis the way some of our competitors tend to move in and out of deep discounts.
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"Well, our niche has always been, and probably will continue to be for the foreseeable future, the difference in the raw product and the way we deliver it."
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The combo meal is something that really, I think, helped the quick service business package meals and get people to move their average check up over time and we have done that as well. When you pull up to a Wendy's menu or you go into a store you typically see six or seven combination meals put together for you at a total price that is a slight discount from purchasing the items separately. It makes it easier for the customer to order those.
TMF: Just a little bit on two of your big rivals here in the U.S., Burger King and McDonald's. What do you think are the key reasons to explain why your customers choose Wendy's over your bigger competitors?
Barker: Well, our niche has always been, and probably will continue to be for the foreseeable future, the difference in the raw product and the way we deliver it. And that really goes back to delivering everything made-to-order. We always use fresh beef in all of our hamburgers. We use fresh toppings. We give people the choice from the get-go on what toppings they want. That's a point of differentiation that really separates Wendy's and has for a long time, I think. We use, for example, all white meat whole muscle breast fillet in our chicken sandwich, which is different than many of our competitors. We use all white meat in our chicken nuggets, for example. A number of things like that I think customers know inherently, and that is one of the reasons that they continue to come back.
I think the other reason is the execution, the marketing. You know, they trust Dave. Dave's advertising campaign is now in it's 10th year and Dave has a very believable trust factor with American customers. I think that's helped us because it's been very consistent over a long period of time.
TMF: What do you think is the most commonly misunderstood aspect of your business or the fast food business in general?
Barker: Well, on the Wendy's side, just from a valuations standpoint, probably the Tim Hortons part of our business is the least understood. And if you think about that, it isn't surprising. Tim's is a Canadian chain that we're slowly bringing to the States and it's only essentially in three markets here in the States. So, from a valuations standpoint, it's difficult for people to totally understand it the way they might understand a Dunkin' Donuts or some other business that they have visited on many occasions. So we're working to explain that better to the investment community and to bring it into the States in a way that people will understand it.
TMF: Is there anything in the fast food industry in general that you feel is misunderstood?
Barker: I think basically the demand capacity piece is one that many of the sell-side analysts are starting to understand and some on the buy-side are as well. If you look at the performance of some of the quick service restaurant stocks in the past six to twelve months, I think you see that being reflected. You know, Tricon is reaching 52-week highs and McDonald's has done extremely well. Our stock is up very nicely here in the last several months. I think you are starting to see some of the more larger capitalization restaurant stocks starting to benefit from that macro change and the way that capacity and demand issue is working.
TMF: That about does it for my questions. I certainly appreciate you taking the time to talk with us today.
Barker: Why, thank you, too. Appreciated the time.
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