In her latest State of the Union address, European Commission President Ursula von der Leyen provided the parliament and citizens of Europe with a stark reminder of a problem that continues to plague governments, corporations and individuals around the world.
In her speech, she specifically referenced “the higher cost of living” for millions of Europeans as “THE global crisis” (emphasis mine). Not climate or geopolitical instability or cybersecurity threats, but inflation.
Her warning highlights a theme that has been something of a centerpiece for our portfolio strategy over the past year and a half. With inflation having been established as both structural and secular, it’s clearly not going away anytime soon, hence the need to view every prospective investment through the lens of how higher input costs might impact it.
Perhaps nowhere is this point more salient than in the restaurant industry, where price sensitivity is most acutely felt by customers—especially in the lower-margin fast food segment of the business. And as it turns out, many players in the fast food arena are finding out just how hard inflation is hitting consumers.
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Fast food giant Wendy’s (WEN) recently made headlines when several news outlets published stories on the firm’s persistent struggles in the wake of its latest earnings. The stories referenced numerous problems Wendy’s management is facing, but the biggest one of all appears to be inflation.
It was widely noted that Wendy’s plans to close hundreds of its restaurants around the country in a massive cost-cutting effort, which is part of its recently launched “Project Fresh” turnaround plan. In last Friday’s Q3 earnings call, management expressed confidence in the turnaround effort, even as domestic same-store sales fell by nearly 5% in the quarter.
Tellingly, Wendy’s blamed inflation, as well as a decline in traffic, as major reasons for its Q3 underperformance.
Interim CEO Ken Cook said Wendy’s is “acting with urgency” to facilitate a return to comp sales growth and, to that end, has hired former Yum Brands’ CEO Greg Creed’s consulting firm to “strengthen its brand positioning and enhance marketing effectiveness,” among other strategic measures.
But while Wendy’s management is using the lingo of modern finance to describe its restructuring efforts—replete with terms like “segmenting consumers, “leveraging consulting” and “driving AUVs higher”—the customers themselves have resoundingly made clear the number-one issue that needs to be resolved: higher checkout prices.
In a Yahoo Finance article by Alicia Kelso, the comment section was rife with complaints over rising ticket prices and, in some cases, accusations of lower food quality at Wendy’s. Here’s a sampling:
“Perhaps sales are down because everything has decreased in size except the price, which has gone up.”
“Wendy’s used to be one of our go to places [but] sadly, the prices have skyrocketed so much over the past few years that now we choose other fast-food places when needing quick food.”
“If the food is brought back to the level of quality it had in say, 1999, people will pay the higher prices. They changed the fries, the burgers, the buns, even the pickles, and the taste suffered across the board. Even the Frosty does not taste as good.”
“It’s not a mystery. People used to get fast food because it was convenient, fast and cheap. It’s no longer feels convenient, it’s no longer fast and it’s definitely not cheap anymore. Toss in the lack of quality these days and it’s a wonder any of them are still open.”
So there you have it; the customers have spoken and they’re obviously not pleased with what they’re seeing at Wendy’s (and at other takeout joints, too, apparently). Unsurprisingly, higher costs were the number-one complaint cited in the article’s comment section.
However, some of the underlying problems at Wendy’s don’t have a quick fix, including labor costs. The Yahoo article noted that Wendy’s “cited commodity and labor inflation” as reasons for its declining performance. With many states now mandating minimum wages at $15 an hour or higher (the so-called “Fight for $15” initiative)—and with that being the current nationwide median hourly pay for fast food workers—Wendy’s faces significant headwinds from this ongoing development.
I don’t pretend to have the answer for the firm’s cost inflation conundrum, nor will I make any proposals for how Wendy’s can successfully right-size the company. What I will say is that, as turnaround investors, we must remain prudent in approaching any potential stock purchase when the company in question faces an abnormally high cost burden.
Unfortunately, that tends to be the case for most food service companies these days, hence my recommendation that investors avoid adding such stocks to their portfolios until the economic climate improves.
To learn more about the turnaround stocks I’m recommending now, subscribe to Cabot Turnaround Letter today.
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