The Best Bet Among the Hamburger Chains

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fast-food sector is one of my favorite sectors. The concept has been proven time and gain to be a long-term winner. An added bonus is the franchise model that delivers low overhead, high margins and steady cash flow. My favorite company in the fast-food category right now is Wendy's (NASDAQ: WEN)

Overview

Wendy's is the world's third-largest hamburger chain. There are more than 6,500 locations in the U.S. and 27 other countries. The focus at Wendy's has been on reducing the number of company-owned locations. In fact, it just announced the sale of 425 company-owned locations that will reduce its ownership share from 22% to 15%. Wendy's ultimate goal is to undergo a complete transformation as a franchiser with a fresh perspective on its logo, menu items, and restaurants.

So far, it's working. For the second quarter, adjusted EBITDA grew 15% to $102.1 million. Adjusted earnings per share grew 60% to $0.08. The company-operated restaurant margin improved 260 basis points to 16.7%.

Latest buzz

Wendy's is getting a lot of attention for two of its latest initiatives, the first being its new restaurant design. The company is making a bold step in its new restaurant design with wi-fi, digital menu boards and the most talked about item – fireplaces. Yes, fireplaces! The plan is to make each restaurant more inviting to get people to linger and continue to order items off of its menu.

So far, 80 locations have already been remodeled and another 200 will receive an upgrade by the end of the year. By the end of 2015, Wendy's hopes to have more than 600 locations renovated. The 80 stores that have already been renovated have seen sales increase 25% at each location.

However, the biggest buzz for Wendy's is its Pretzel Bacon Cheeseburger. There's a lot of excitement about the product, not only from consumers but the investment community as well. Janney Capital Markets analyst Mark Kalinowski raised his rating on Wendy's to a “buy” after the Pretzel Bacon Cheeseburger was announced.

The Pretzel Bacon Cheeseburger was rolled out in July and is the hottest product for Wendy's since the company launched high-end salads in 2002. When salads were introduced, they brought in increased traffic and produced same-store sales increases of 5% or higher in three-out-of-four quarters in 2002. Wendy's also sees plenty of potential with the Pretzel bun in that it could be used in other products.

Competition

Wendy's biggest competition is from its two larger competitors – McDonald's (NYSE: MCD) and Burger King Worldwide (NYSE: BKW). Both are focused on franchising, with McDonald's stores being about 81% franchised, and Burger King at 97%.

McDonald's is getting a boost as July same-store sales rose 0.7% globally and 1.6% in the U.S. Sales growth for the company is seen in its new chicken McWraps and egg-white breakfast sandwiches. Breakfast is a strong part of the day for McDonald's, especially as the U.S. economy has recovered and more people are using the McDonald's drive-through to start their day. McDonald's sales are also being driven by the company's Dollar Menu, which the fast-food giant has been advertising.

In Europe, McDonald's has been advertising its combo meals to cash-strapped Europeans to help boost sales in that market. Europe was the weakest market for McDonald's last month, where same-store sales fell 1.9% across the continent. In France the company has advertised baguette sandwich-and-drink combos. In Germany, McDonald's has promoted new snack salads and wraps with arugula and couscous. All of this is in addition to its regular value meals.

A turnaround in Europe would give McDonald's a real boost, because its gets about 40% of its revenue from there and the company has about 2,700 stores in France and Germany alone.

According to Zack's, Burger King saw second-quarter adjusted earnings per share come in better than expectations. Earnings per share came in at $0.21 per share as the company saw benefits from its re-franchising strategy. Burger King re-franchised 305 stores in the second quarter and will likely have its re-franchising initiative completed by the end of this year.

Overall, comparable-store sales rose 0.6% in the second quarter. In terms of a specific breakdown of comparable-store sales, the strongest regions were Europe, the Middle East and Africa with 2.9% growth and Asia with a 3.9% increase. The U.S. and Canada posted negative results of 0.5%, but that was an improvement over the 3% decline in the first quarter.

In the U.S., Burger King is focused on refurbishing its locations. Last year, the company refurbished about 600 locations, or about 19% of its total locations. The goal is for about 40% of all locations to be refurbished by 2015. Restaurants that have been refurbished have seen an average increase in sales of between 10% and 15%.

Foolish assessment

Wendy's, in my opinion, is making the right moves to be the best bet among the hamburger chains. Wendy's is known for its quality food and is looking to differentiate itself from McDonald's and Burger King by being more like Panera Bread and Chipotle Mexican Grill. Both Panera and Chipotle offer good quality food in attractive settings. Wendy's has an edge in that its menu is priced lower than Panera and Chipotle.

Another key reason for owning Wendy's is that it has plenty of room for growth overseas. Wendy's doesn't have the presence outside of the U.S. that Burger King or McDonald's has. Besides it menu innovations, like the Pretzel Bacon Cheeseburger, and remodeled stores, I see international expansion being the third leg of growth for Wendy's. 

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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