Wendy’s Is on a Roll, With Surging Free Cash Flow Stoking Shares Higher

The Wendy’s Company (NASDAQ:WEN) reported surging earnings and free cash flow (FCF) on May 12 for the March first quarter. More meaningful, though, was management’s 2021 outlook increase. From that, it’s clear that WEN stock is worth considerably more than its present price.

How much more? At least 45% higher to $33.79 per share, by my calculations.

How can I be so specific about this? It’s simple. I base this on a projection of its FCF using the FCF margin that the company produced in the first three months of this year.

Projecting Free Cash Flow

Wendy’s reported $121 million in EBITDA (earnings before interest, taxes, depreciation, and amortization) as well as $97.5 million in FCF in Q1. This was on sales of $460.2 million in the period. In other words, the EBITDA margin was 26.3% and its FCF margin was 21.2%, or $97.5 million and $460.2 million, respectively.

Analysts now believe that the company’s earnings growth, as seen in Q1, will continue throughout the rest of this year and next. For example, sales were up 13.6% in the quarter year-over-year. This analysts project total sales of $1.85 billion, up 5.78% over last year’s $1.73 billion. Next year, sales will hit $1.9 billion, or up 2.70%.

Frankly, these are not really all that impressive growth rates. The 2021 sales growth rate of 5.78% and 2022 rate of 2.7% are not what will push WEN stock higher. It’s the level of EBITDA and FCF margin.

For example, let’s assume that the company makes a 26.3% EBITDA margin on those forecast sales of $1.9 billion. That works out to EBITDA of $500 million. In addition, using a 21.2% FCF margin on $1.9 billion in sales is $402.8 billion in FCF. We can use these projections to value WEN stock.

What Wendy’s Is Worth

If you look at a number of Wendy’s QSR peers, you will see that the forward enterprise value-to-EBITDA multiple ranges from 24 to 66 times. So, if we used even a 20x multiple, the enterprise value for WEN stock will be $10 billion (i.e., $500 million x 20 = $10 billion). After deducting $3.32 billion in net debt on Wendy’s balance sheet, the equity market value is $6.77 billion. This is 32% above today’s market value of $5.13 billion and is equivalent to a target price of $30.85 per share.

Similarly, we can use FCF to estimate the future value of WEN stock. For example, let’s value WEN stock using a 5.0% FCF yield. This is significantly higher than its present dividend yield of 1.72%, so that makes it a conservative estimate.

Therefore, if we divide $402.8 million in 2022 FCF by 5%, the equity market value works out to $8.06 billion. This represents a potential gain of 57.1% over today’s $5.13 billion market value. This is equivalent to a target price of $36.73 per share.

What To Do With WEN Stock

Now we have two price targets, based on EV-to-EBITDA ($30.85) and FCF yield ($36.73) valuation methods. The average price target between the two is $33.79, or 45.8% over the June 25 closing price of $23.17. This could take up until mid-2022 or longer to achieve, as it is based on 2022 estimates. So, at worst over a one-a half-year period, the ROI would be 28.1% annually for 1.5 years.

Data collected by TipRanks showed that 22 analysts have an average 12-month price target of $26.34. This represents a potential gain of 13.05% over the next year. This is substantially lower than my 28% expected return figure.

But I believe that the company’s surge in FCF and EBITDA earnings will spark a revaluation of WEN stock. For example, analyst Poonam Arora, writing on Seeking Alpha, projects that Wendy’s will benefit from a set of factors. These include a mixture of its growing international sales, breakfast menu, delivery, and return to dining. Those factors will rejuvenate the company’s sales. As a result, her price target is $31.55, or 35.4% over today’s price.

Her accuracy? She is ranked #250 out of 8,085 bloggers on TipRanks.

So, between my estimate, the 22 analysts collected by TipRanks, and analyst Arora on Seeking Alpha, WEN stock will be much higher this time next year. My best guess is that it will rise 45% to $33.79.

On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.