STRATEGIC PARTNERS
CIBC lifts view on fast-food chain, downgrades Wendy's.
January 23, 2005
Glass said McDonald's has an impressive lineup of new products for 2005, which should allow the fast-food behemoth to deliver another "decent year" of same-store sales growth. Same-store sales, a key measure of profitability in the sector, tallies sales at stores open for more than year. The products expected to boost McDonald's sales include a fruit/yogurt entrée salad, upgraded coffee and a new premium chicken sandwich. "We think the chicken in particular is a big winner," said Glass. At its European operations, sluggish sales should be bolstered by the introduction of a full-time value meal in Germany, more premium salad and chicken offerings across the continent. There is also more potential for management changes in Europe to better align operations. Turning to its financial position, Glass said McDonald's should see a rise in free cash flow based on moderate capital expenditure growth in 2005. He estimates 2005 capital expenditure will rise "modestly" to $1.6 billion from $1.4 billion to $1.5 billion in 2004, with free cash flow increasing to $2.7 billion from $2.6 billion. In light of his upbeat view for McDonald's in 2005, Glass raised his stock-price target to $38 from $36 and his 2005 earnings estimate to $2.08 a share from $2.05. Glass is less positive on Wendy's outlook for 2005, although he continues to view the company's shares favorably in the long term. Aside from increasing from competition from McDonald's in the U.S., Wendy's also faces cost pressures to due rising beef prices. Glass said Wendy's beef purchases are highly correlated to live cattle futures prices, which are expected to pick up again from the second quarter onward. "Assuming live cattle future prices remain relatively stable at the current level of 90 cents per pound, (admittedly an unlikely scenario), we estimate Wendy's 2005 beef costs could be up 4 percent vs. 2004," said Glass. Elsewhere, Wendy's is suffering from lackluster results from recently acquired New England chain Tim Horton's. This is worrisome for Glass, who sees the expansion of the chain as the "single biggest growth opportunity" for Wendy's. Wendy's is also struggling to turn around its Baja Fresh fast-food chain. Glass noted the company's aggressive attempts to cut losses at the chain by announcing the closure of up to 18 underperforming Baja restaurants. The move could lead the chain to break even on an operating basis in 2005. However, "the track record is poor on this score and further losses would cause reductions in earnings estimates." Glass maintained his 2005 earnings forecast for the company at $2.40 per share, which is below the Thomson First Call average estimate of $2.44 per share. Glass said he still views Wendy's as the best operator in the fast food sector, even if near-term momentum may favor the competition. "We currently prefer the stability, free cash flow and diversification of McDonald's," said Glass.
