Shares of Wendy's (WEN) are under pressure on Tuesday after the company announced the launch of a breakfast menu scheduled for 2020 and cut its fiscal year 2019 guidance due to related costs. Following the news, both Guggenheim analyst Matthew DiFrisco and BTIG analyst Peter Saleh downgraded Wendy's to Neutral.
BREAKFAST LAUNCH: On Monday, Wendy's announced that it plans to launch its breakfast menu, currently available in more than 300 restaurants, across the U.S. system in 2020. The menu features items that take "the best of Wendy's, from Applewood smoked bacon to the Frosty, and creatively delivers them to fans for breakfast," the company stated. Signature items will include the Breakfast Baconator, Frosty-ccino, and Honey Butter Chicken Biscuit.
GUIDANCE CUT: The company also cut its fiscal year 2019 adjusted earnings per share growth view to 3.5%-6.5% from 3.5%-7%, as a result of its intention to enter the breakfast daypart across the U.S. system in 2020. Wendy’s expects to make one-time upfront investments during 2019 of approximately $20M to support the U.S. system in preparation of its national launch. All other elements of the company's 2019 outlook remain unchanged. In addition, the company is removing its 2020 goals as it intends to update these goals and provide additional long-term guidance at its Investor Day on October 11, 2019, including additional details regarding the expected financial impact of entering the breakfast daypart. During 2019, as a result of the breakfast investments, the company now expects adjusted EBITDA approximately flat to down 2%, cash flows from operations of approximately $290M-$305M; free cash flow of approximately $215M-$225M, down approximately 2.5%-7%.
MOVING TO THE SIDELINES: Following the news, Guggenheim's DiFrisco downgraded Wendy's to Neutral from Buy as he views the day-part expansion as a sign of slowing near-term momentum in the lunch and dinner business. The analyst also noted that Wendy's previous attempts to establish a breakfast business in 1985, 2006 and 2010 were unsuccessful and pressured franchise margins, calling the new attempt "a potentially risky way to add topline growth." While he acknowledged what breakfast could ideally represent over time, as it improves the brands value appeal and enables for expanded hours to better capitalize on delivery, he argued that breakfast does not appear to be growing in aggregate demand, as evident by McDonald's (MCD) struggles at the day-part.
Voicing similar concerns, BTIG's Saleh also downgraded Wendy's to Neutral from Buy following the company's announcement of a system-wide breakfast launch planned for 2020. The analyst believes the launch could prove to be an "uphill battle much like the previous attempt." Saleh is cautious on the prospects given the required upfront investment but uncertain payoff, additional labor needs at a time of already low availability, necessity to take market share from established competitors like McDonald’s and general difficulty of daypart expansion in the industry. While be does not want to be “overly harsh,” his skepticism inclines him to move to the sidelines.
BREAKFAST COULD DRIVE UPSIDE: Reiterating a Buy rating on the stock, SunTrust analyst Jake Bartlett raised his price target on Wendy's to $24 from $22 as he believes the breakfast launch could drive "meaningful upside" to same-store sales and EBITDA estimates in fiscal year 2020. While the company has struggled with similar initiatives in the past, Taco Bell's (YUM) success in 2014 shows that it can be done, the analyst contended. Bartlett also added that the prize is "worth the risk."
BMO Capital analyst Andrew Strelzik also reiterated an Outperform rating and $21 price target on Wendy's following the news. The analyst noted that the announcement represents a growth opportunity, even though it introduces a layer of operational and financial risk that he had previously not assumed.
OTHERS TO WATCH: In addition to McDonald's and Taco Bell, other publicly traded companies that compete in quick-serve breakfast include Restaurant Brands' (QSR) Burger King and Tim Horton's, Dunkin' Brands (DNKN) and Starbucks (SBUX).
PRICE ACTION: In late morning trading, shares of Wendy's have dropped about 13% to $19.18.