Arby's problems run deeper than menu prices

LOS ANGELES Mon May 17, 2010 11:49am EDT

LOS ANGELES (Reuters) - Roast beef sandwich chain Arby's has made a new $1 menu a cornerstone of its turnaround plan, but it may not fix what ails the deeply troubled brand.

Executives at parent Wendy's/Arby's Group Inc WEN.N have blamed Arby's deteriorating sales on menu prices that were higher than the typical fast-food chain. But early results from the launch of Arby's $1 menu showed that the benefit of more traffic has not outweighed the risk to profitability.

Value menus have helped fast-food companies ranging from McDonald's Corp (MCD.N) to sandwich chain Subway weather the weak economy. But the $1 menu from Arby's came late to an already-crowded market with things like curly fries and down-sized roast beef and ham and cheese sandwiches.

"Arby's performance is amongst the worst in modern restaurant history," J.P. Morgan analyst John Ivankoe said in a note. Systemwide sales at established company-owned Arby's units fell 5.8 percent in 2008 and 8.2 percent in 2009. During the first quarter of 2010, they tumbled 11.6 percent, he said.

Beyond that, Oppenheimer analyst Matt DiFrisco said Arby's reported its lowest margins yet during the first quarter -- when it began rolling out its $1 menu -- offsetting gains at sister brand Wendy's.

"We are not fully convinced that Arby's challenges are purely cyclical," Bernstein Research analyst Sara Senatore said, adding that other restaurant chains recently got a lift from improving consumer sentiment and spending.

When it comes to reviving a struggling brand, "it's not easy and not particularly cheap," Senatore told Reuters.

In addition to fierce competition and rampant discounting, Arby's is also up against an emboldened McDonald's, which is stealing industry market share.

The world's biggest hamburger chain has all-day value menus, lots of money for advertising, fancy coffee and 14,000 well-run and maintained restaurants in some of the country's best locations.

LOSING ON LOYALTY

The economy is partly to blame for some of the sales declines at Arby's, but experts said it already was suffering from neglect when it merged with Wendy's in September 2008 in a deal orchestrated by Nelson Peltz's Triarc.

"They were on the decline before the economy went south," said Brand Keys President Robert Passikoff, who added that when it comes to customer loyalty, Arby's comes in last even though it has carved out its own niche.

"Their engagement loyalty bond is so weak that their own customers are rating them low," Passikoff said, adding that they do have room to capitalize on their core business. "They're the only national chain that offers roast beef. If you want roast beef, they're the only game in town."

While turnarounds are difficult, Technomic's Bob Goldin said troubled companies can focus on their strengths to reconnect with customers. For example, coffee chain Dunkin' Donuts got its mojo back after it embraced its blue-collar clientele, positioned itself as the "anti-Starbucks" (SBUX.O) and got its operational house in order.

MID-TURNAROUND

Wendy's/Arby's is controlled by billionaire Peltz, who serves as chairman, and Vice Chairman Peter May. Triarc, their investment company, owned Arby's.

The two men also were investors in Wendy's. Wendy's/Arby's Chief Executive Roland Smith ran Arby's at various times during his career.

The parent company is in the second year of a three-year turnaround. Analysts say Wendy's business appears healthier and on track for future growth, helped by advertising focusing on fresh ingredients, new food and value menus.

Wendy's floundered after the death of its founder Dave Thomas in 2002, but the chain that operates 6,000 units had not deteriorated as much as Arby's ahead of the merger.

Wendy's/Arby's has started long-overdue renovations at Arby's 3,500 units and plans to make significant improvements at 75 percent of them over three years.

It named a new president for Arby's last week and is working with the roughly 10 percent of its franchisees that are struggling with debt.

During April, the first month of national advertising for the $1 menu, Arby's same-store sales at company-operated restaurants fell a "dismal" 8.4 percent, in the words of J.P. Morgan analyst Ivankoe, while traffic was up 4 percent.

Value menus are designed to spur visits so that operators can talk diners into buying high-profit add-ons like drinks. But this was not yet happening at Arby's, where the average spend per diner fell 12 percent in April.

Arby's will introduce a toasted steakhouse sub and a "prime cut" chicken sandwich this quarter. Those "premium" priced products could help boost diners' average spend, analysts said.

Meanwhile, the brand is weighing on overall results at Wendy's/Arby's, which is lagging rivals.

So far this year, its shares are up just 2 percent compared with the nearly 12 percent gain in McDonald's shares and the more than 14 percent rise in the Dow Jones U.S. Restaurant and Bars index .DJUSRU.

Arby's "path to recovery looks longer and shallower than we expected," said Bernstein's Senatore.

(Reporting by Lisa Baertlein; Editing by Michele Gershberg and Matthew Lewis)