NEW YORK (CNN/Money) -
Wendy's International may come to remember 2005 as the year of the "chili finger."
The fast food chain was dealt a blow in March when a woman claimed she found a human finger in her chili at one of its San Jose, Calif., restaurants. Authorities later discovered the claim to have been a hoax, but not before the incident whipped up a media maelstrom and contributed to disappointing first-quarter same-store sales at Wendy's restaurants.
However, it looks like the brouhaha surrounding the surprise digit has done little to dampen investor enthusiasm for Wendy's. Shares of Wendy's have jumped 16 percent since the beginning of the year and, at Thursday's $44.59 close, are trading just a shade off their 52-week high of $45.89.
Wendy's has come a long way since it opened its first Old-Fashioned Hamburgers restaurant in 1969. With more than 9,700 stores nationwide, Wendy's International (Research), which also owns coffee and doughnut chain Tim Hortons and Baja Fresh Mexican Grill, is one of the world's largest restaurant operating and franchising companies.
The company's revenue hit $3.64 billion last year, and steady growth has helped Wendy's capture the No. 3 spot among the nation's hamburger businesses, trailing only McDonald's (Research) and Burger King. Wendy's even earned a spot on the Fortune 500 list of the nation's largest corporations this year for the first time in its history.
But given the weak sales during the past few months, can this company's stock remain as hot as a bowl of chili?
Where's the beef?
Wendy's clearly has some work to do to rejuvenate the image of its namesake restaurants. Same-store sales at Wendy's restaurants -- which have averaged annual gains of about 3.5 percent over the past 10 years -- have slid lately due to tough competition in the fast food industry. And sales were falling before the chili incident.
In the first quarter, the company said bad weather and higher beef prices contributed to the sluggish sales, but that it expected to see sales improve in the second half. But Banc of America Securities analyst Andrew Barish isn't as bullish on the company's sales outlook, particularly since it has been slow to introduce new products -- a lifeblood of the trendy fast-food business.
Wendy's has hinted that it will move up the launch of its new line of deli-style Frescata sandwiches to 2005 -- which indicates how concerned the company is with sales, Barish wrote in a research report. But even with the acceleration of that rollout, he doesn't think it will hit the market until 2006.
The company is also trying to boost sales by updating its image to appeal to younger consumers, who tend to be big fast-food customers. This week, it rolled out a new advertising campaign that features the tag line "Do what tastes right."
The humorous ads mark a departure from the group's previous marketing promotions, which played on the company's Midwestern wholesomeness embodied by the late founder and spokesman, Dave Thomas.
The doughnut strategy
While Wendy's tries to get people to eat more burgers, many on Wall Street say that the company's true growth potential may lie not in its traditional square patties, but in its Tim Hortons stores.
Although Tim Hortons accounts for less than one-third of Wendy's International's total number of restaurants, the business, started by a former professional hockey player, contributed more to the company's operating income than Wendy's restaurants did in the first quarter.
And operating profit margins at Tim Hortons in the first quarter were 24.5 percent versus margins of just 7.5 percent for the Wendy's restaurants. Tim Hortons' stellar performance hasn't gone unnoticed by the Street -- two hedge funds recently took sizable stakes in the company, triggering speculation that the doughnut and coffee business would be spun off.
In March, Pershing Square Capital Management acquired shares and options in Wendy's that could give it a 9.3 percent stake in the company. At the time, the firm said it intended to meet with management to suggest changes to enhance shareholder value. Another investment outfit, Highfields Capital Management, acquired a 6.1 percent position last month.
If the hedge funds are successful in convincing management to pursue certain strategic initiatives, such as spinning off Tim Hortons into a separate entity, the stock could be worth as much as $64 to $76 per share, Merrill Lynch analyst Rachael Rothman wrote in a research note.
But Rothman cautioned that this price range is solely based on a "what if" scenario. It isn't clear what exactly the hedge funds have in mind and a spokesman for Wendy's said the company does not comment on speculation or market rumors.
Is it too late to get in the game?
Wendy's has endured its fair share of teasing following the "chili finger." But the stock is no joke.
The company is a long-term solid performer, with analysts looking for annual earnings growth of 12 percent for the next five years. "This is a good long-term buy," said Dean Haskell, analyst at JMP Securities.
But interest in a potential break-up has pushed the stock up to a level that many analysts say is a bit pricey. Wendy's trades at 19.5 times analysts' estimated earnings for 2005. That's on par with the valuation for fast food rival Yum! Brands (Research) but it is much more expensive when compared to McDonald's (Research), which trades at a P/E ratio of about 16.
And according to Thomson/First Call, only two analysts rate Wendy's stock a "buy" or "strong buy," while 16 give it a "hold" rating, which is usually a negative sign on Wall Street.
The company may have bounced back from some unwarranted bad publicity. But with Wendy's stock riding high on spin-off rumors, it might be better to wait for market speculation to cool down before picking the shares up.
Analysts quoted in this story do not own shares of the companies mentioned. JMP Securities has no investment banking relationship with the companies but Merrill Lynch and Banc of America Securities do.
Click here to read about Burger King's plans to sell chicken fries.
Click here to read about rival McDonald's push into the late-night market.