Thursday, November 8, 2012

This Restaurant is Not Tasty Now

Buffalo Wild Wings (NASDAQ: BWLD) got crushed in the stock market after its Q3 earnings announcement. The share plunged nearly 12% in a day, from $83.50 to $74.70 per share. It lost nearly $164 million in market capitalization with that single drop. It sounds scary for investors, but the drop is nothing compared to the 485% gain BWLD experienced from Nov 08 – Mar 12. Will this stock soar again, or keep heading south? A deeper look into business fundamentals will help. 
In the third quarter, total revenue experienced a 24.8% year-over-year increase, from $197.8 million to $246.9 million. 92.5% of total revenue came from restaurant sales, and only 7.5% were franchise royalties and fees. Its same-store sales rose 6.2% at company owned restaurants and 5.8% at franchised ones. However, the impressive revenue growth still missed Wall Street’s estimates; analysts expected revenues to have been $253.9 million. And even with the double-digit growth, its net income declined from $11.27 million Q3 2011 to only $10.7 million third quarter this year. Q3 2012 EPS came at $0.57, a little lower than last year EPS of $0.61. The decline in profit was due to higher restaurant operating costs including cost of goods sold, labor, operating, and occupancy. Sally Smith, the President and CEO, said in a conference call: “We're pleased with our strong top-line growth of nearly 25% in the third quarter. We focused on operational excellence at the restaurant level and our teams delivered strong same-store sales. In addition, we leveraged on labor, operating, and occupancy expenses. High cost of sales and incremental pre-opening expenses moderated our bottom-line expansion, producing earnings per diluted share of $0.57 compared to $0.61 in 2011."
The interesting thing is the company’s confidence to grow its restaurants to 1,700 within the next five to seven years, higher than previous forecast of 1,500. Buffalo currently has only 854 restaurants, with 343 company-owned and 511 franchised. And with this growth prospect, it has a goal to achieve 20% net earnings growth on a 52-week basis in 2013. Its 2011 net income was $50.43 million, so in order to have a 20% net earnings growth for a continuous two years; it should deliver $60.52 million in 2012 and 72.6 million in 2013.
What I like about Buffalo Wild Wings is the debt-free operation. As of September, it has $31.3 million cash, $52.5 million marketable securities, and $365.8 million stockholders' equity. It has $184 million liabilities, but no interest-bearing debt. At the current price of $75.87, the total market capitalization is $1.41 billion. The market is valuing BWLD at 25.8x P/E, 4x P/B and 9.8x P/CF.
Buffalo Wild Wings’ direct competitors are private companies such as Carlson Restaurants Worldwide, Fox & Hound Restaurants, and Hooters of America. So in a broader view, we can somewhat compare Buffalo to its peers in the fast food/quick restaurants industry includingDarden Restaurants (NYSE: DRI)Ruby Tuesday (NYSE: RT) and Chipotle Mexican Grill(NYSE: CMG).

Net margin (%)
ROIC (%)
Over the previous twelve months, Buffalo Wild Wings’ net margin is comparable to Darden Restaurant’s, around 6%. Even with much higher return on equity that Darden delivers, but Buffalo Wild Wings outweighs Darden in terms of return on invested capital. Darden’s high return on equity of 25.5% is due to significant financial leverage of 3.24x. Ruby Tuesday is the only company, which had negative trailing twelve months loss. Chipotle is the best performing restaurant chain, with 24.7% return on invested capital and 10.4% net margin. However, it is the most expensive with 29.2x P/E. Whereas Buffalo Wild Wings has a comparable net margin to Darden’s, but comparable P/E valuation to Chipotle’s (in fact, just a little lower).
My Foolish Take
With a disappointing profit decline in the third quarter, rising raw material costs, Buffalo Wild Wings would be justified with a lower valuation. Even with an 11% daily drop in the share price, I did not think BWLD is cheap enough at 25.4x P/E. I’d rather wait for another price drop and/or an improvement in its operating results to initiate a position in the company. 

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