Small-Cap Spotlight: Buffalo Wild Wings on the Hot Seat

In this week's small-cap spotlight, Frank and Larsen take a look at Buffalo Wild Wings(BWLD), which operates more than 420 casual dining restaurants in the U.S.

Shares were recently trading at $41 and have been on a tear over the past 12 months as management has capitalized on America's growing appetite for wings. After the recent run, the company's short position has increased to about 25%, suggesting that many investors believe the stock may be getting a little ahead of itself.

Frank and Larsen offer their views on whether it pays for investors to get into a stock that is up more than 50% since January or if they have missed the boat.

Curzio: Step Up to the Plate

Being a huge sports fan, I can definitely relate to the average weekend bar scene that includes screaming fans rooting for their favorite teams, drinking their favorite beer and eating piles of their favorite bar food -- Buffalo wings.

Management at Buffalo Wild Wings has been taking full advantage of this trend, and I believe shares in this stellar performer have at least 15% upside in the short-term -- following today's downgrade by investment firm Merriman Curhan Ford -- and could offer takeout potential down the road.

Starting with valuation, shares are trading at 32 times 2008 earnings, according to Capital IQ, which is considerably above the industry average of 20. But I believe this number is deceiving given some recent developments.

Back in March, Buffalo Wild Wings entered into a contract that locked in a fixed price of $1.23 per pound for wings for the remainder of the year. This is significant given that chicken wings -- the company's largest cost -- accounted for 24% of its total cost of goods sold in 2006 and that the market rate for wings last quarter was $1.40 per pound. The supply agreement will give more clarity on the earnings front for the rest of the year and could decrease the odds of a downside earnings surprise in the short-term.

Also, the company effectively passed on a cost increase to the consumer in 2006 and intends to raise prices further this year -- by an average of 4%. I do not see this reflected in the current consensus estimates and the increase combined with the fixed contract for wings for the remainder of the year could provide an earnings boost for the next few quarters.

On the growth front, the company is expected to increase earnings by 25% over the next five years, a seemingly conservative estimate based on the strong results posted by recent store openings and the expected roll-out of new stores. The company announced that during the first quarter, the average weekly sales of newly owned and franchised restaurants outpaced same-store sales gains.

As for new openings, management intends to have 1,000 restaurants opened by 2012 -- more than double the 439 that are currently open. With over $70 million in cash and zero debt, the company's solid balance sheet will help fund its aggressive growth plans.

Click here to see a video with Frank and Larsen about Buffalo Wild Wings