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Deflation, Sales Leverage Drove Wendy’s 1Q16 Earnings Margin

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EBIT margin

In 1Q16, Wendy’s Company (WEN) posted EBIT (earnings before interest and tax) of $63.8 million, which represented an EBIT margin of 16.9% compared to 11.3% in 1Q15. Analysts were expecting Wendy’s EBIT margin to be 15.2%.

Deflation and Sales Leverage Drove Wendy’s 1Q16 EBIT Margins

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EBIT margin drivers

Wendy’s 1Q16 EBIT margin rose as a result of lower commodity prices and sales leverage due to positive same-store sales growth. Due to lower commodity prices, the company’s cost of sales as a percentage of total revenue fell from 32.3% in 1Q15 to 30.5% in 1Q16.

Due to sales leverage, the costs of occupancy, advertising, and other operating costs fell from 23.6% to 23% in the quarter. Despite a rise in labor wages, the cost of labor fell due to sales leverage and operational efficiency.

However, a rise in G&A (general and administrative) expenses from $59.7 million in 1Q15 to $64.6 million in 1Q16 offset some of the expansion in Wendy’s margins. Increased professional fees and legal reserves and increased incentive compensation led to a rise in the company’s G&A expenses.

Peer comparison

In 1Q16, McDonald’s (MCD), Jack in the Box (JACK), and Restaurant Brands International (QSR) posted EBIT margins of 30.2%, 15.3%, and 38%, respectively, compared to 25.3%, 13.5%, and 39.5%, respectively, in corresponding quarter of the previous year.

Outlook for 2016

Analysts expect Wendy’s, which forms 0.02% of the holdings of the iShares Russell 1000 Value ETF (IWD), to post EBIT margins of 17.3%, 19.7%, and 23.8%, respectively, in 2Q16, 3Q16, and 4Q16. Overall for 2016, analysts expect Wendy’s EBIT margin to rise from 15.3% to 19.2%.

Positive same-store sales growth and a 3% deflation in commodity prices are expected to drive the company’s EBIT margin in 2016.

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