The Wendy’s Company Financial Analysis
Executive Summary
The Wendy’s Company founded by David Thomas in Ohio is a fast-food chain of companies that has made great progress since its foundation. David Thomas named the company after his daughter Wendy. Despite the fast-food industry is a lucrative business venture, it has faced its fair share of challenges, such as opposition from consumer groups over the health concerns raised. There has been a growing competition among the industry players forcing most firms to keep their prices low. The global recession did not destroy Wendy’s company through the volume of sales fell during the recession. However, the company has managed to survive amidst all the difficulties it had to overcome. This paper seeks to analyze how the company has managed to sail through the harsh business environment.
Background
The Economy
Wendy’s company like any other business enterprise contributes vehemently to the economy of the country and the global economy at large. Being a franchised group of restaurants, the inequalities experienced by different states of the United States do not make operations easier1. The company is not immune to the alterations in the national and global economies and financial markets.
The Beverage Industry
Industry Characteristics
The beverages in question are soft drinks. The sector is fragmented and characterized by a bipolar nature. This is because the industry is dominated, on one hand, by huge multinational companies like Coca-Cola and Unilever; while, on the other hand, many small and medium-sized businesses produce beverages for the local market.1 The industry use preservation facilities like refrigerators and preservatives to enhance the shelf-life of their products.
Sales Characteristics
The sale of carbonated soft drinks among teenagers has raised concern among their parents and consumer activists. The inclusion of these drinks in the individual diet in the United States has been viewed as a big challenge to a healthy lifestyle today. The soft drink companies have launched an aggressive advertising campaign for their product through newspapers, displays in supermarkets, and on television. The beverage industry like any other industry has a variety of sources from which it gets its finances. The basic source is the accrued profits. This is obtained through the sale of the products of the beverage industry at a price higher than the cost of production.
Sources and Uses of Funds
The benefits accrued by a beverage firm should be used in a transparent and accountable manner. The funds obtained are used to pay the wages and salaries of employees that work for the particular company. This is a means of appreciating employees’ efforts and motivating them to work hard to achieve the goals and objectives of the business enterprise.
Causes of Changes in Industry Prospects
Many factors can lead to a change in the industry prospects. One of these factors is the change in demographics. Most beverages are popular among the youth, and any changes that may occur in the young population demographics will adversely affect the projected level of sales. For instance, in countries that emphasize family planning to control births, it will reach a time when the population consists mainly of the elderly, thus there will be less demand for cola drinks.
The Solid Food Industry
Industry Characteristics
Most fast foods have an agricultural origin. As such, the demand is inelastic in that a slight change in the availability of the product largely affects the price. For instance, if there is a 5% improvement in the harvest of vegetables, salad manufacturers will have plenty of farmers to buy from, although it is difficult to increase the consumer demand in the short run1. Thus, the salad manufacturer is not likely to purchase more vegetables, and the prices will fall by more than 5%. Seasonality of some of these foods is also an important characteristic of the industry1.
Sales Characteristics
The fast foods sold in the United States include French fries, hamburgers, and salads. Many petrol stations have a one-stop store where the fast foods are sold to people “on the go”. The majority of such outlets offer take-away services that allow customers to pick food from their cars. In various parts of the world, fast foods are nowadays sold on the streets. The vendors offering such services use all possible approaches, such as bright advertisements, a wide range of meals on the menu, etc., to attract the people who pass by.
Sources and Uses of Funds
The Food Industry like any other business enterprise can obtain its funds from commercial banks and other financial institutions.3 These are funds that require security/collateral and attract interest rates by the lending institutions. The food company also obtains funds as revenue through the sale of its products and services. The firm can also get funds through the sale of assets. The company can as well lease its property at a fee to other firms. However, the government can intervene through grants and tax relief to help the company raise funds. These funds are obtained through borrowing from friends and family. They should be used in a transparent and accountable manner. The revenue realized must be applied to settle the debts the firm might have to avoid being bankrupt as a result. The creditors need to be paid
Causes of Changes in Industry Prospects
In 2000, consumers in the United States alone spent about US$110 billion. The National Restaurant Association made a forecast that in 2006, the sales volume of the restaurants would reach US$ 142 billion; it is about a 5% increase from the 2005 consumption level.1 However, nowadays, fast food loses its top place in the market due to the competition from fast-casual dining restaurants.2
The Wendy’s International, Inc.
Background and History
Wendy’s is an international chain of restaurants dealing with fast foods that were founded by Dave Thomas in Columbus, Ohio in the United States of America in November, 1969.3 The company moved its headquarters later to Dublin, Ohio in January 2006. Wendy’s Restaurants is the founding company of Wendy’s International, Inc. which is the owner and franchisor of Wendy’s restaurants in America. Since 2008, it has been under the ownership of Triarc (now called Wendy’s Company). The name was changed from Triarc Companies Inc. to Wendy’s/Arby’s Group Inc in the same year.1
On March 1st, 2012, the Management of Wendy’s restaurants comprised:
The President, Chief Executive Officer, and Manager———Emil J. Brock
Senior Vice President, Chief Financial Officer, and Manager —-Stephene E. Hare
Senior Vice President and Chief Accounting Officer and Manager—– Steven B. Graham
Chairman, Board of Directors————————————Nelson Peltz
Vice-Chairman, Board of Directors———————Peter W. May.
Products
The Wendy’s Company is involved in the business of operating, establishing, and franchising a system of unique quick-service restaurant chains serving high-quality fast foods. French fries are the primary side item though other options for side items like salads, chili, wraps, and baked potatoes are also available. Frosty deserts are also sold well. Frozen dairy desserts occur in chocolate and vanilla flavors. Lately, Wendy’s company has introduced Frosty Shakes which are a blend of frosty and either vanilla dean, strawberry, chocolate fudge, wild berry syrups, Caramel, topped with whipped topping and syrup. Frosty Parfaits were introduced in place of Twisted Frosty in 2011.
Market and Distribution Channels
The market is determined by many factors like economic ability, cultural factors, social standing, government policies, availability of competing firms, geographical locations, seasonal variations, and demographic structure. In its marketing, Wendy’s company has made attempts to employ a differentiation strategy. Under this approach, the company has mainly invested in continuous research and innovations of new products.2 It has also made various modifications to the nutritional formulations of various products to make them unique based on conducted consumer research.
Competition
The level of competition necessitates that Wendy’s fast-food chains deliver high-quality services to retain their customers since any careless handling of customers or any imperfections in the product will lead to the loss of customers to the competing firms.4 Some competitors in the fast-food industry have adopted a system whereby they offer menu items that are targeted at specific consumer groups or dietary trends. Some competitors have applied a low-cost policy to attract low and medium-income earners.
Production Facilities
The production facilities include Oldemark Limited Liability Company, The New Bakery Co. of Ohio, Inc, Wendy’s Global Services, Inc, Wendy’s Support Centre Limited Liability Company, Wendy’s International, Inc, Wendy’s of Denver, Inc, Wendy’s of N.E. Florida, Inc, Wendy’s Old Fashioned Hamburgers of New York, Inc, Wendy’s Restaurants of New York, LLC.
Promotional Activities
After its initial impressive growth, Wendy’s company later experienced stiff competition that led to a decline in sales. Such a scenario prompted the company to engage in promotional activities to regain its former glory. It majorly invested in advertising through the media. The products of Wendy’s were featured in films, televisions, and on ABC’s Reality Show, The Extreme Makeover, where over 100 construction workers were shown to be served with its food. The advertising costs are shared among the company-owned restaurants and the franchised ones based on the percent of retail sales.3
Acquisitions
The Wendy’s company has on many occasions acquired the interests of its restaurants and sold off some of its company-owned restaurants to the franchisees. The company evaluates strategic acquisitions of franchised restaurants and strategic disposal of company-owned restaurants to existing and new franchisees. Among all these arrangements, however, Wendy’s retains the right of first refusal to any proposed sale of a franchisee’s interest.
Historical Financial Statements (Appendix)
Inventories
The company’s inventories are stated at much lower costs than that of the market with cost being determined per the “first-in, first-out” principle. They consist primarily of restaurant food items and paper supplies.4
Investments
Wendy’s company and its subsidiaries have various investments in real estate, limited partnerships, and non-current investments. The company has had a considerable influence on investees in a partnership in a Canadian restaurant real estate joint venture. Such investments are evaluated using the equity method. The difference between the carrying value of equity investments and the underlying equity in the historical net assets of every investee is accounted for as if the investee were a consolidated subsidiary.
Properties, Depreciation, and Amortization
Properties are stated at internal costs including employees who are involved in specific restaurant construction projects. Depreciation and amortization of capital assets are computed on a straight-line basis using the following classification based on the lifespan of 1-20 years for office and restaurant equipment, 5-15 years for transportation equipment, 7-30 years for buildings, 7-20 years for improvements in the owned site.
Trends in Growth and Variability
The operations at Wendy’s restaurants are seasonal, with the revenues being higher during the summer months than the winter months. Due to these fluctuations, the results for any future quarter will not be indicative of the results that may be achieved for another quarter of the full financial year. At Wendy’s chains, when Thomas Davis was alive, there were an impressive number of customers visiting its restaurants. Soon after he died in 2002, the organization’s market share fell from 14.5% to 13.6%. It faced stiff competition from McDonald’s and Burger King, and other innovative chains like Five Guys and Fries.
Ratio Analysis
Current Ratio
This is the relation between the current assets and current liabilities. It measures the liquidity of an enterprise. It is calculated as:
Current Ratio = Current Assets / Current Liabilities.
It represents the margin of safety or cushion that creditors have in the business. It is an index of a firm’s financial stability and technical solvency. A higher current ratio indicates that a firm is more liquid and can pay its current obligations in time. The Wendy’s company had a current ratio of 2.0 in the year ended January 1, 2012. This implies that the current assets double the current liabilities, thus the company has a satisfactory financial position.4
Fixed Assets Turnover ratio
This value is obtained as a net sales-to-fixed assets ratio. It estimates the capacity of a firm’s fixed assets to generate net sales. When this ratio is applied, a higher ratio indicates an intensive utilization of fixed assets in the generation of revenue. A lower ratio indicates the underutilization of fixed assets.
Fixed Asset Turnover = Net sales/Fixed Assets.
Upon calculation, Wendy’s company had a turnover of 1.8 in January 2012. Higher ratios indicate efficiency in managing the fixed assets to create sales.
Return on Equity Capital
It is a relationship between the profits and a company’s equity. ROEC = {(Net profit after tax – Preference dividend) / Equity share capital} x 100. The Wendy’s company had a ROEC of 0.86% on January 1, 2012. This implies that for every equity share, there was a profit of 0.86% on the value of the equity share capital. This value is not impressive since it indicates lower profitability.5
Quick Ratio
It is used to indicate a firm’s liquidity in the short term. It gauges the ability of the firm to fulfill its short-term financial obligations using its liquid assets. When this ratio is applied, a higher value indicates that a firm can meet its current liabilities in time.
It is calculated as Quick Ratio = (Current Assets – Inventories)/ Current Liabilities.
The Wendy’s company has a ratio of 1.5 after calculation for January 2012. This indicates that Wendy’s current assets available to offset current liabilities exceed the current liabilities by half the value of the current liabilities after lessening the inventories from the current assets. The ratio is above the conventional value of 1, thus the company’s performance is satisfactory.
Gross Profit Margin
This represents the proportion of funds remaining from the revenues after taking care of the cost of goods sold. It is used to pay other expenses too.
Gross profit margin = (Revenue – COGS)/ Revenue.
The calculated value of Wendy’s as of January 2012 was 26.2%. This implies that the Gross Profit was 26.2% of the value of the revenues. The amount available for settling other expenses was 26.2% of the revenue collected.
Analysis
- I – Initial Pro Forma Financial Statements (Appendices Section 2)
- II – Determination of the Cost of Debt
- The cost of debt is the effective rate that a company pays on its current debt. It is important as it gives an idea of the overall rate being paid by the firm to use debt financing. It also gives an idea of how risky the company is. The higher the cost is, the riskier the business is. Therefore, the after-tax rate can be established by the method: {Pre-tax rate x (1- marginal rate)}.
- III – Determination of Cost of Equity
- It refers to what it costs a company “to maintain a share price that investors are comfortable with”. The cost can be calculated using the capital asset pricing model (CAPM).
Capital Assets Pricing Model (CAPM)
Cost of Equity (Re) = Rf + Beta (Rm – Rf) where:
Rf – Risk-free Rate (Amount obtained from investing in securities that are free from credit risk)
Beta – a measure of how much a firm’s share price moves against the market as a whole.
(Rm – Rf) -Equity Market Risk Premium: It represents the difference between the market rate and the risk-free rate.
Rf = 4.5%, (Rm-Rf) = 5.0%, Beta = 1.05.
CAPM = 4.5 + 1.05(5.0) = 9.75%
Expected Rate of Return on a Security
This is a factor that is necessary when evaluating and selecting an investment. It can be computed using various methods. One of the methods is the Single Period Rate of Return which is a percentage price appreciation plus the percentage cash return during a given period. *Single Period Return = %price appreciation + %cash return.*
Risk –Free Rate
This value constitutes the interest an investor expects from an investment that is free of risk over some period.
Beta Coefficient
This is a figure that measures the relative volatility of a stock. It shows how much the stock price fluctuates compared with how much the stock market is dynamic. If the share price is consistent with the market, then the stock’s beta is 1. A beta of more than one indicates that the share is exaggerating the market movement. A beta of less than 1 indicates a stable share. A stock having a 1.5 beta coefficient will rise by 15% if the market rises by 10% and fall by 15% if the market decreases by 10%.
Expected Return on the Market
Based on the information available, this value can be obtained using historical sample averages of realized returns in the market. It can also be obtained using the second model which assumes that the expected excess in the market (a – r) is constant. The historical average excess return on the market is added to the current observed interest rate. The model takes into account the inflation level but not the level of risk associated with the market.
Market Risk Premiums
This is the difference between the risk-free rate and the expected return in the market portfolio. It is equal to the slope of the security market line (SML). The historical market risk premium will be uniform to all investors since the value is based on what happened. The required and expected market premiums will vary from investor to investor based on risk tolerance and styles of investing. *Market Risk Premium = Expected Return of the Market – Risk-free Rate*
Calculation of Cost of Capital
Cost of capital is the returns required to “make a capital budgeting project to build a factory”. It determines the avenues through which the company can raise funds. It is the rate of return that a company would receive if it invested in a different venture with similar risks. In calculating the cost of the capital, we must first examine the cost of debt and cost of equity separately as outlined earlier. Then, we should calculate the proportion that each contributes to the entire firm. Finally, we weigh the cost of every capital based on the proportional contribution of each to the entire capital structure, to obtain a Weighted Average Cost of Capital.
- IV – Determination of Weighted Cost of Capital
This is obtained by proportional comparison of the components of the capital structure based on their contribution to the entire capital of the firm.
Per Share Market Value of the Firm
The main steps used in calculating involve subtracting the dollar value of the dividends paid on preferred stock from the company’s net income. The value obtained is the numerator. The numerator is then divided by an average number of common shares. The resulting value is the value per share of common stock.
Market Value of the Firm’s Equity
As established within various financial documents, this value refers to the total dollar market cost of a firm’s outstanding shares. It is obtained by “multiplying the firm’s current stock price by the number of its outstanding shares. It is used to measure a company’s size and helps investors in diversifying their investments across companies of different sizes and varying levels of risk”.
Market Value of a Firm’s Debt
This is the value of debt calculated according to current market rates and current interest rates. The debt may involve securities like stocks and bonds as well as bank debt. *Market Value of Debt = (Market value of debt in securities + Book debt in Bank loans) *
Calculation of Cost of Capital
Where:
Re = cost of equity =9.7%
Rd = cost of debt = 6.7%
E = market value of the firm’s equity = $4.95
D = market value of the firm’s debt = $2.85
V = E + D = 7.80
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate = 21.6%
WACC = (9.7 * 4.95/7.80) + (6.7 * 2.85/7.80)[1-0.21] = 8.09%
- V – Investment Decisions
Discounted Cash Flow Assumptions
The main assumptions include the treatment of all cash flows as if they occur at the end of the year. Discounted Cash Flows assume that the capital market is perfect. DCF methods also assume that all cash inflows are reinvested in other viable projects that generate revenues for the firm. Another assumption is based on the last that the capital market is perfect. Lastly, DCF methods state that cash flows associated with investment projects are known with certainty, while risk adjustments can be made in an NPV analysis to account for cash flow uncertainties.
Internal Rate of Return (IRR)
This can be defined as the discount rate that is commonly used in capital budgeting that makes the “net present value of all cash flows equal to zero”. The higher the IRR is, the more desirable the business venture is.
Net Present Value (NPV)
This is the summation of all the present cash flow values of a business firm. It represents the difference between the present value of cash inflows and outflows. It is used to analyze the profitability of an investment.
The Is are income amounts per year. The discount rate is r. The number of years the investment lasts is n. r represents the IRR.
- *VI – Intermediate Pro Forma Financial Statements (Appendix Section 2).
- VII – Financing Decisions
Cash Inflow Determination
Cash inflow comprises the money received by a firm through its operations, investment activities, and financing activities. Other ways through which cash flows into the firm include payment for goods and services from the customers, shareholder investments, interest on savings and investments. Cash inflow can be determined using accrual accounting where the transaction is counted as paid when it comes in.
Investment Choices
The available investment choices include stocks, mutual funds, college savings plans, auction-rate securities, annuities and insurance, bank products, futures, and options.
External Opinion
The external opinion of auditors can help the company determine its current financial position and its viability to survive the harsh market conditions. This is because the auditor gives a professional opinion on the fairness and accuracy of the financial statements. The various business regulatory bodies are also important in advising the firm concerning its operations.
Internal Opinion
The financial opinion of the company’s employees is also important for its survival. Various professionals may have very valuable opinions from their professional point of view. For instance, if there is a need for extra staff, the company can buy modernized equipment to improve the staff performance. The internal auditors determine the extent to which the firm adheres to managerial policies, procedures, and requirements. They give their opinion on the firm’s financial statements.
Ratio Analysis
The various financial ratios that are crucial to a company include Gross profit margin, Pre-tax profit margin, return on equity, Return on Assets, Price/cash flow ratio, working capital per share, Debt/common equity ratio, Inventory turnover, Leverage ratio and Quick ratio as explained earlier.
Current Capital Structure
This is a combination of the company’s short-term debts common equity and preferred equity.3 It is how a firm finance all its operations by using various sources of funds in the short term. It is a company’s debt-to-equity ratio, which provides an insight into the level of risk of a firm.
EBIT – EPS Analysis
This involves the calculation of the earnings per share at different levels of sales. We assume a certain level of sale and calculate the earnings apart from interest and taxes (EBIT) at that level. We then calculate what the earnings per share (EPS) will be for each alternative form of financing.
EBIT = Operating Revenue – Operating Expenses
= ($2431.4 – $429.0) million
= $2002.4 million.
Preference and Implementation of Financing Method
The method of financing chosen should be flexible in terms of the repayment period. The method must also be consistent with the rules and regulations concerning the finance sector. The funds should be obtained from a reliable source. Preference should be given to that method that offers the most affordable/lowest interest rate and gives a long repayment period.6
- *VIII – Final Pro Forma Financial Statements (Appendix 2).
- *IX – Final Pro Forma Ratio Analysis
The various financial ratios that are crucial to a company include Gross profit margin, Pre-tax profit margin, Return on equity, Return on Assets, Price/cash flow ratio, Working capital per share, Debt/common equity ratio, Inventory turnover, Leverage ratio and Quick ratio as explained earlier. These ratios are instrumental in financial planning and control. The ratios can be categorized into profitability ratios, Turnover ratios, and leverage ratios.
- X – Dividend Policy
This is the policy applied by a firm to decide how much it will pay out to shareholders in dividends. It impacts investors and perceptions of the firm in the financial market. The dividend policy depends on the situation of the firm currently and will have the same impact on the preferences of investors in the future.
- XI – Sensitivity Analysis
This is a method used to determine how different values of an independent variable will affect a specific dependent variable under certain assumptions. It is a technique used with specific boundaries that will depend on other input variables. It is a way of predicting the result of a decision if a situation turns out to be different.
Summary and Conclusion
Wendy’s company like many business establishments is operating under uncertainty of the future. This is due to the difficulty to make accurate predictions on the factors behind such uncertainties and the fact that they are beyond the company’s control. Such factors include competition from current or new entrants into the fast-food business and similar services. Pricing pressures have not made the uncertainty any easier. The industry is facing challenges from an outbreak of food-caused illnesses that have raised concerns over food safety.
Bibliography
Bernstein, L, Financial Statement Analysis, Prentice Hall, New York, 1983.
Coleman, A, Financial Accounting and Statement Analysis: A Manager’s Guide, Thomson Learning, New York, California, 1988.
Kapil, S, Financial Management, Dorling Kindersley Pvt. Ltd, New Delhi, 2011.
Wahlen, P, Financial Reporting: Financial Statement Analysis and Evaluation, Cengage Learning, Boulevard, 2008.
Appendix 1
Historical Financial Statements
The Wendy’s Company and Subsidiaries Consolidated Balance Sheets (In Thousands)
The Wendy’s Company and Subsidiaries Consolidated Statements of Operations (In Thousands Except per Share Amounts).
The Wendy’s Company and Subsidiaries Consolidated Statements of Stockholders’ Equity (In Thousands)
The Wendy’s Company and Subsidiaries Consolidated Statements of Cash Flows (In Thousands)
The Wendy’s Company and Subsidiaries Consolidated Statements of Cash Flows – Continued (In Thousands)