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
Another positive is that Buffalo Wild Wings owns 30% of its stores. (The balance are franchised.) In fact, the company announced back in May that it will purchase eight high-sales-volume franchise restaurants in Las Vegas. These assets, along with a solid balance sheet and positive free cash flow, increase the potential of a takeover.
Last, the company is in the early stages of a national advertising campaign that will certainly increase brand awareness. This is essential given that management intends to increase its store base by 20% annually over the next five years.
I believe that Buffalo Wild Wings' growth potential supports its high valuation and that management will continue doing a great job in expanding its presence across the U.S. In the short-term, the company is likely to exceed estimates, as it has done in each of the previous three quarters, which could result in a 15% move to the upside from current levels.
Kusick: Don't Be A Pig
Frank paints a nice picture of all the positive developments at Buffalo Wild Wings, and there's no arguing the strong financial results the company has posted in 2007. Management's execution on an aggressive growth strategy has been superb, and investors who got in at the end of last summer have come close to tripling their investment.
But looking forward, Buffalo Wild Wings makes me think of an adage that Jim Cramer and other experienced investors often cite: "Don't confuse a good trade with a good investment."
There are a number of things I like about this stock. First and foremost, I love seeing a high short ratio, and Buffalo Wild Wings has about 25% of its outstanding shares held short right now. When looking for a good trade, I like seeing a big short position because it provides the fuel needed for fast upward moves. Earlier this week we saw a great example of such a move, as shares shot up 10% on Tuesday after CIBC released bullish comments on the stock, saying a premium valuation is warranted and future upside earnings results are likely.
Translation: This is a good stock to ride for a short-term trade. This opportunity stems from the questionable valuation-based thesis the shorts are employing here. A company in the midst of a successful expansion should not have 25% of its float shorted. These guys are just asking to get squeezed, in my opinion.
But there are red flags flying around this stock that could crush its momentum over the next six months and stop me from calling this an investment at this point.
Anyone who looks at a chart can see that Buffalo Wild Wings has had quite the run over the last year. Would I say the stock is overbought now? Perhaps, but taking a long-term perspective, the more accurate assessment appears to be that there are some pretty high expectations priced into the stock now.
The CIBC note I mentioned earlier was a positive for investors in the short-term, but also sets the bar higher for the company going forward. At a certain point, simply hitting the consensus earnings estimates for a quarter isn't good enough anymore. The market will start expecting the company to beat the numbers to the point where even a solid quarter won't satisfy investors. Remember that just last week shares of Goldman plunged eight points after the company beat analyst estimates by 14 cents -- sentiment and expectations play a big role in whether you make or lose money during earnings season.
This is important because of the premium valuation Buffalo Wild Wings shares are being accorded. The stock is trading at 39 times 2007 earnings estimates and 32 times 2008 estimates. I'm never shy about paying up for a growing company when I feel they have some advantage over their competitors (I've been a fan of
for some time now), but in this case I don't see any qualities that make Buffalo Wild Wings better than other restaurant stocks over the long run.
is an established brand that is poised to increase earnings 18.6% next year and trades at less than 20 times 2008 earnings estimates. Meanwhile, Buffalo Wild Wings has yet to establish itself beyond its niche status, but trades at the aforementioned 32 times earnings despite 2008 earnings growth of about 22%, just 3% more than Sonic.
By itself, the valuation isn't a big negative in my view, but it puts a damper on the upside for investors. Looking long-term, I want to maximize my potential return if I'm getting into a stock that could get clobbered if it has just one weak quarter.
Another thing that makes me hesitant to take a long-term bullish stance on Buffalo Wild Wings is that I don't see how the company is truly differentiating itself from other restaurants.
If you listen to this month's presentation at the June 6 Piper Jaffray Consumer conference, CEO Sally Smith talks about the company's continued menu expansion beyond wings, which already make up only 24% of sales. So essentially we're looking at a company that established its brand as an alternative to mainstream brands like
, Chili's, T.G.I. Friday's and others, yet is headed down the path to becoming just another kitschy family dinner joint.
You can't argue with management's solid execution to date, and that's why current shareholders can probably get a little more out of shares on a short squeeze. But the long-term upside picture isn't as rosy in my opinion. If you're looking for a stock to buy right now and hold for the rest of 2007, this wouldn't be my pick.