Wendy's Beefs Up in the Burger Wars

Wendy's (NAS: WEN) investors received some much needed good news recently. The fast-food chain became the No. 2 burger seller with regard to domestic sales volume, surpassing Burger King with $8.5 billion in sales to its rival's $8.4 billion, according to research firm Techmonic.

Unfortunately, that change seemed to come more from Burger King's troubles than any great thing Wendy's is doing right. While Dave Thomas' brainchild was creeping ahead of Burger King, Subway and Starbucks (NAS: SBUX) zoomed past the two burger chains to No. 2 and No. 3 in U.S. restaurant sales, respectively.

The past few years have left Wendy's shareholders with nothing but an upset stomach. After falling off a cliff during the financial crisis, the stock experienced none of the recovery of the broad market. A share that was once worth more than $21 in 2007 now trades near $5. Just this year, the stock is down 6% in spite of the greater bull market, and the restaurant chain has struggled to achieve consistent profitability. Recent attempts to revamp the company are promising, though.

Escaping the grease trap
In June 2011, Wendy's sold off the flailing Arby's chain for the equivalent of $430 million. The two restaurant groups had merged in a $2.3 billion deal in 2008, part of what sank Wendy's shares that year.

The company is testing out new "ultra-modern" store prototypes, which feature a fast-casual-style ordering queue, new Redhead Roasters branded coffee, digital signage, and a Wi-Fi bar.

Its stores aren't the only areas getting a redesign. Wendy's has attempted to step up its food quality, focusing on a new flagship burger, Dave's Hot N' Juicy, and improved "natural-cut" fries. Unfortunately, it seems the only thing natural about the fries is that the skin's left on. Former Chief Marketing Officer Ken Calwell explained that actually making the fries all-natural instead of just calling them natural wouldn't jibe with his customers' desire for cheap, convenient food. That seems to be the ultimate dilemma for Wendy's.

In the age of fast casual, it can't decide whether to commit to modernizing or sticking with the traditional fast food formula. While fellow heavyweight Burger King has also languished with no sales growth over the past five years, McDonald's (NYS: MCD) has soared by co-opting successful rival initiatives like Starbucks' espresso drinks and Chick-Fil-A's trademark chicken sandwich. Wendy's has not yet shown it's capable of the same dexterity, however.

Burgers are trendy these days, with the nationwide expansion of Five Guys, the growth of Danny Meyer's Shake Shack, and a number of smaller chains sprouting up. While this means competition for Wendy's, it also creates an opportunity. With more than 6,000 locations nationwide, its footprint in the burger industry is only surpassed by McDonald's and Burger King. After that, no one comes close.

Menu for success
Wendy's needs to commit to food quality. Calling its fries natural isn't enough; it needs to follow through on that promise. With a large number of locations and extra features like drive-throughs, it has a potential advantage over fast-casual chains such as Chipotle (NYS: CMG) , Panera (NAS: PNRA) , and Five Guys. These competitors hit back on the perceived quality front, though -- consider the success of McDonald's healthier menu options, or the nationwide growth in organics -- and that has meaningfully played into the success of those restaurants. Improving food quality is its best chance at rejuvenation.

With that improvement in food quality comes the necessary store redesign and rebranding in the customer's mind. Hiring a former Procter & Gamble exec to replace Calwell seems like a step in the right direction. The store prototypes look sleek and give the chain a modern feel similar to other fast-casual chains. Even McDonald's has gotten with the times, revamping stores by eliminating the jarring interior colors and downplaying Ronald McDonald and his cast of characters. With the Golden Arches set to spend more than $1 billion on redesigning its stores, the logical question for the struggling Wendy's is where it would get that kind of money. Fortunately, there's an easy answer to that.

Despite its inability to turn a stable profit, Wendy's has been aggressively buying back shares over the past three years. In that time, the company has spent about $400 million, or 20% of its market value, on share buybacks with nothing to show for it in terms of stock growth.

Successful managers know that you create a valuable enterprise by taking care of your customers first, who in turn take care of your investors. For a company that's losing money to be spending about the same amount buying back shares than on capital expenditures is just unacceptable. If Wendy's can redirect itself to become a restaurant that people want to visit first and a vehicle for growing shareholder wealth second, taking care of its investors will take care of itself.

Wendy's management may still have some work to do to convince investors its restaurant is a good bet, but luckily our stock pickers at the Fool have found three American brands that have not only found success at home but are also reaping huge returns abroad. They're all household names that have given consistent market-beating returns to their shareholders through stock appreciation and dividends. Find out more about these investments that are sure to be golden for another generation in our special free report: "3 American Companies Set to Dominate the World." You can get your free copy right now.

At the time this article was published Fool contributorJeremy Bowmanowns shares of Chipotle Mexican Grill but holds no other positions in the companies in this article. The Motley Fool owns shares of Panera Bread, Starbucks, and Chipotle Mexican Grill.Motley Fool newsletter serviceshave recommended buying shares of Chipotle Mexican Grill, Starbucks, Procter & Gamble, Panera Bread, and McDonald's, creating a bear put spread position in Chipotle Mexican Grill, and writing covered calls on Starbucks. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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