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The Growth Report September 26th 2001
Vol. 1 Issue 5
“Coffee and Donuts”
Consumers are going to spend less as personal safety and anxiety grips the United States in response to the Twin Towers tragedy. Regardless of the trading activity following the terrorist attacks, it should be noted that the markets had already been showing signs of a pending recession. Americans were already suffering from a heightened fear of job security. The terrorist acts have only exacerbated this trend. With second quarter growth expected to fall from the already low 0.2% and third quarter expected to be significantly hit in the wake of the terrorist attacks, there is little doubt that the U.S. is on the verge of entering a recession as this is being written.
As a result, these next two quarters will be most affected by profit shortfalls, reduced consumer spending and a rising unemployment rate. Consumer spending is likely to hit all manner of purchases at this time. Travel is obviously a hot topic right now with obvious concerns of air travel as fears of further attacks or reprisals for U.S. retaliation dampen holiday and business travel across the U.S. continent. As travel is hit, hotels continue to suffer. There were reports last week that hotel occupancy rates in New York and Las Vegas were in the 10-15% range and hotels were laying off staff as a result. The US$26 billion tourist industry of New York has already shown signs of consumer withdrawal with at least 5 Broadway shows cancelled to date. Computer and automobile manufacturers have already remarked that there has been a slow-down in demand. The Growth Report would be surprised to hear of any company responsible for the sales of luxury items such as jewelry or big-screen TV’s not suffering in the aftermath.
These trends have been with us for a while but are now coming under the microscope more that in the past as the affects of the September 11th attacks are calculated industry-wide. As the stock markets tumbled in 2000, Americans tightened their spending plans and even the much publicized tax cuts and steep interest cuts have had little noticeable improvement. Indeed, these cuts have only had the affect of masking the general reluctance and concern of the American population’s financial well-being and have been a crutch for U.S. growth as it stumbles along in 2001.
With all this being said, investment becomes an exercise in finding recession-proof stocks and industries. Over the next couple of weeks, the Growth Report intends to comment about a number of companies that would appear to have a solid future in otherwise quicksand like market conditions.
Coffee and Donuts…
Love and marriage, love and marriage, go together like…well horses and carriages aside, coffee and donuts are loved and married together by the near universal craving of caffeine and sugar.
There is an interesting phenomenon we’ll call ‘brown bag syndrome’. It can be seen by almost any of us in most of our workplaces. Despite the contraction in the North American economy, this is a habit and a hard habit to break. With this in mind, Growth Report believes that selective fast food and beverage establishments are more recession-proof than many other service industries. Which leads to the rhetorical question – how many cups of coffee and donuts could a $300 handout from the tax department buy?
The stock market collapse and general economic slowdown will have made a typical ‘non-brown bagger’ more price sensitive which is why we have focused our Buy Recommendation on Wendy’s International (NYSE:WEN) which offers low-cost, no frills menus in both its Tim Hortons and Wendy’s chains.
Wendy’s International (WEN:NYSE)
$26.49 Close September 25th 2001
114 million shares outstanding
$29.38 52wk high
$18.62 52wk low
$3.02 billion market capitalization
Restaurant chains reported sales fell from 5 percent to 20 percent in the week following September 11th, as Americans stayed glued to television screens for reports on the attacks that destroyed the World Trade Center twin towers and damaged the Pentagon. While also subject to economic factors, the lower average prices and high volume lunch business can provide some support for quick service restaurants. Brinker International Inc. (NYSE:EAT) runs, amongst other chains, Chili's Grill & Bar. "We had some days when people were glued to television sets," Brinker spokesman Tim Smith said. "There were a couple of days where there was significantly less traffic at all retail establishments, but traffic is much more normal now." Growth Report believes that a continued ‘Television’ impact will be seen in full-service sales due to a contraction in the economy as well as the high likelihood of continued crisis-related television coverage keeping people at home.
Price conscious habits….
My friend, Raymond, and I were watching Monday night football the other night at a local bar. I was in the process of telling Raymond my thoughts with regard to the spending habits of people in the wake of recent events. We both commented that people were far more likely to be buying wings at 25c each than paying $25 for a steak. He is in the brewery service industry and further commented that a patron of a bar would be more likely to buy their favorite beer in draught form than in a more expensive bottle format. The list of cost-cutting goes on, and from your own personal experience I will not bore you with more examples at this time. Suffice it to say, our lives will continue at a level approaching normality over the coming months; however, we will try to live a similar life a little cheaper. This bodes well for the Quick Service Restaurant (QSR) business at the expense of the full-scale (and fuller price) restaurants.
Wendy’s consists of two separate and complementary entities. The Wendy’s name is legendary with Dave Thomas’s old-fashioned hamburgers. Wendy’s has over 6,000 outlets in the U.S. making it the 3rd largest hamburger chain with a 12.7% market share. It has been very successful against its peer group. Sales growth in 2000 was 7.2% against 3% at McDonalds and –1.3% at Burger King. The company has also been aggressive in its expansion plans. In 2000, Wendy’s sales outlets grew by 4.7% against 1.4% for McDonalds and 2.3% for Burger King. According to Jack Schuessler, chairman and CEO of Wendy’s International, the company has had same stores sales growth averaging 3.8% over the last 12 years – better than anyone else in the QSR industry. Wendy’s stores have produced average unit sales increases for 64 consecutive months. Wendy’s plans to expand the chain by 300 stores per annum, with particular focus on the U.S. and Central and South America.
In 1995, Tim Hortons merged with Wendy's International, Inc. While Tim Hortons continues to operate as a separate entity, the merger provided a new focus for the expansion of the Tim Hortons concept in the United States. Tim Hortons locations can presently be found in Michigan, New York, Ohio, Kentucky, Maine, and West Virginia. The Canadian operation is 95% franchise owned and operated, and plans in the U.S. call for the same key strategy to be implemented as expansion progresses. Tim Hortons is Canada’s largest coffee and baked goods chain with more than 2,000 stores across the country, and more than 100 stores in the U.S., based mainly in the Buffalo, New York; Columbus, Ohio and Detroit, Michigan markets.
Tim Horton’s is as much a part of the Canadian vocabulary as hockey, which in no small way is a surprise as the company was founded by the great Canadian hockey player Tim Horton. Its legendary coffee and customer loyalty have made it a strong, well-branded corporate entity which fulfills the insatiable need of police officers and office workers alike to have their morning, afternoon and evening fix of coffee and donuts.
On a personal note, during recent travels I noticed a Tim Hortons open up at the bottom of an office building where Starbucks (SBUX: NASDAQ) had had a monopoly on coffee sales. I thought to myself I’ll try a Tim Horton’s today and went to line up. There were 20 people waiting in line (they are served very quickly I later find out) so instead I go over to the Starbucks counter where there was no one buying coffee. Have the days of a $3 cappuccino been replaced by a $1.25 coffee and donut special? People still want their coffee but in the current economic conditions its conceivable they don’t need gourmet caffeine!
Last year the two chains combined produced net income of $170 million or $1.44/per share. The company has been tireless in paying an annual dividend totaling $0.24/share and has strong cash-flow from its business operations. The pre-tax income split was roughly 30% Tim Hortons and 70% Wendy’s. Given the customer loyalty of the Tim Hortons brand and the low-cost nature of the food and beverages that both chains provide, Growth Report feels that Wendy’s can buck the overall contraction in consumer spending and continue to grow strongly over the coming years. The company has already reported guidance for next year of 11-13% growth, down from 18% in 2000. It is too early to determine the full impact of recent events but we expect them to be negligible on the business going forward. We recommend the shares of Wendy’s International as a BUY with a 6-12 month target of $32.00/share and a stop-loss of $22.30/share.
Happy Investing,
Doug Ramshaw
Editor-In-Chief
Growth Report |
