Buffalo Wild Wings: Costs Are Getting Out of Control

I’d like to write a longer piece on Buffalo Wild Wings (BWLD), but time constraints are forcing me to go with this. Fortunately, my case is easy to make. The price action in this stock has presented one of the most obvious trades in the current market. Simply put, there is no way this company can live up to the current expectations embedded in the stock. As I write this, the stock is hitting a 3 month high of nearly 37. It’s up over 20% in the last 2 weeks. Now, many stocks have made those kinds of moves in the last 2 weeks, but the vast majority that have were down 30-40%+ in the preceding 3 months, not up over 50%, as BWLD was (using a November low of roughly 20). There’s also a huge gap in the chart, as there has been several times in the last few years. For some reason, investors keep bidding up this stock, even though every time in the last 2 years there’s been an up gap in the stock, it’s been filled in the next 3-4 months. Some may blame short covering for the continuing rally, but I would note short interest as a percent of float has been increasing in the last weeks.

While I find the chart compelling, fundamentals will ultimately drive the stock. This is where we have a true disconnect. With an EV/EBITDA of nearly 10X, the company is valued 30% higher than the peer group median of 6.3X. The same is true of earnings – a PE of 27X(!) versus a peer group median of 19X. The peer group I’m using is DIN, DRI, TXRH, EAT, RT, DENN and DAVE, although the numbers don’t change much when I use a larger peer group of 33 companies as well. Perhaps their performance justifies the valuation? While BWLD has shown better revenue and EBITDA growth than peers, it’s not astounding, and the company has been expanding faster than peers as well.

Same stores sales growth has been good but is notoriously volatile. Margins are generally better than average, but in line with peers, and peer margins have recently been distorted by large non-cash charges, particularly at DIN. When earnings are distorted I like to turn to price/tangible book, and this is perhaps the most egregious: 4.2X versus a peer median of 1.8X. I happen find my peer analysis even more compelling in light of the fact that I view the entire industry as overvalued, but it works on a standalone basis as well.

I reject any “soft” reason to own this stock. Things I frequently hear: Management is “executing the strategy”. The “concept” is clicking. Consumers are “trading down”. Management? They’ve just executed one of my favorite short signals: Moving into a swank new headquarters replete with a triangular (triangular? OK, whatever) board room table. That they’re selling stock hand over fist shouldn’t concern you – it’s nothing new (they’ve been selling for years) and they’ll get generous stock awards to replace it (comp is not really excessive, but the consistent selling is a clear issue). The “concept”? Sports bar. Brilliant. Totally proprietary. Consumers? Unemployment is at 8.1% and rising. The company has fought the trend so far (just like I’m fighting the tape), but I can’t see credible reason why its performance should continue at its current pace, or at the pace implied by the stock price.

A few other items: People often like to claim they have “a ton of cash and no debt”. Admittedly, the cash position is nice in this environment, but $180M in operating leases looks a fair amount like debt to me. The use of FIFO inventory accounting is usually a red flag. The accounting effect of transitioning 9 Las Vegas stores from franchised to owned is unclear, but the purchase price of over $2M per store in that market certainly looks aggressive.

Finally, let’s look at our favorite topic, chicken wing prices. The effect of wing prices on their EPS is well documented. The company has paid around $1.20 for wings for the last few years. So far this year, wing prices have been north of $1.50, and may well average $1.80 or more in March. One cent increase in wing prices translates roughly into one cent decrease in EPS, so they may well be looking at a 30 cent headwind on EPS next year. How it plans on translating $1.43 last year into the ~$1.75 range (management’s estimate of 20-25% growth) with that headwind, in this economy is beyond me.

I’d like to write more, but the message is pretty simple and this will have to suffice. It’s a cheap beer and wing joint. It should sell for 7-8X EV/EBITDA in a normal environment and 4-5X in the worst recession in recent memory. I’ve shorted this stock every time it’s gone north of 30, and looking at the chart, it’s clear this has been a smart strategy. I’m always early, so it may well run to 40, but eventually it will disappoint and we will see the low 20’s again.

Disclosure: Short BWLD.

Comments

[dstb:]

Does the author enjoy sports, beer, and wings? I contend that it is difficult to understand the success of BWLD if you do not. They have taken the sports bar "concept" national and made it friendly for everyone from blue collar beer swillers to college students to families. They have successfully marketed and delivered an "experience" at their stores that goes beyond going to any sports bar. This is the main point and basis of their success. All the food has to be is decent.

The stock may be a little pricey at this point but long term this stock is a great investment as long as management remains in place and continues to stay focused. CEO Sally Smith has executed extremely well on the details. Oh..and by the way, they will have a blowout quarter with the NCAA Tournament this year.

Mar 23 10:42 AM

[captainccs:]

>>>I’d like to write a longer piece on Buffalo Wild Wings (BWLD), but time constraints are forcing me to go with this. Fortunately, my case is easy to make.<<<

You could have saved 29 words by not saying that.

>>>There’s also a huge gap in the chart, as there has been several times in the last few years.<<<

When it closes I'll buy back my calls but I would not short this stock. But then, I never short stocks.

Mar 23 10:43 AM

[John Gordon:]

I suppose when you are a short, Its always easy to look for (and hope for) the negatives. Ourselves, we do not take stock positions, and supply independent restaurant analysis only.

The company's real earnings fundamentals are good, much better than almost anyone in the restaurant universe right now. Consider all of the following:

Postive same store sales--company stores +4.5%, zees 2.5%
Company is adding new units--36 on year to year basis, 18-22 new units (company plus zees) in next quarter.
$2.2M store level AUV isnt bad
Depreciation up but this is a noncash expense--its a good thing, folks! It is a source of cash
Price increase of 4% planned (for Chicken wings and other commodity movements).

For now, BLWD is in that rare position where it is growing stores and comp sales in a very bad economy. Lets take it !

Stock Price: little has happened since week ending 2 February (price $22.67) to week ending 16 March ($36.46) other than the rest of the restaurant universe continues to move sideways or down in real earnings fundamentals.

John A. Gordon
Pacific Management Consulting Group
pacificmanagementconsu...

An analytically focused management consultancy

Mar 23 11:30 AM

[xixM0NEYxix:]

Wow - what a complete buffoon. This has to be one of the stupidest articles I've ever read. As the author said, I too would like to write a longer piece, but here is just one example of the idiocy (I counted at least 3 more as I read the article):

"The use of FIFO inventory accounting is usually a red flag." For a company that turns inventory over 100X per year, really FIFO is a red flag? The cost of their inventory is flushed through the system every 3-4 days!!! Red flag? Maybe, but apparently that is because financial analysis morons are now flying red flags.

I used to read seekingalpha regularly. Their lack of editorial standards evident in this article leads me to immediately ignore all future articles. What an idiot!

Mar 24 08:51 AM

[User 282079:]

BWLD has been able to produce results (Earnings Per Share Growth) consistently over the past 5 years and that has continued through this recession. Investors are willing to pay a higher multiple for growth in this environment b/c it is rare. I would argue that any inconsistencies noted in same store sales may exist from one quarter to the next, but overall performance in this category has done nothing but trend upward.

Mar 24 09:04 AM

[Njord Wind:]

Admittedly, inventory accounting is not a large issue for this company, but then again, it isn't a large part of my thesis. All I said was: "It's usually a red flag". Perhaps you'd care to comment on something more substantive? Please try to avoid name-calling, it's unbecoming.

I was unaware the "sports bar" concept was previously unfriendly to college students and blue collar beer swillers. Has the segment heretofore been accessible only to yuppies and hipsters? The only thing the CEO has executed is sell tickets on her stock, and I'm pretty sure (but I'll double check) that the NCAA tournament occurs every year, so it'll be reflected in the comps already. Except that last year we weren't in the midst of a terrible recession and they were buying wings for $1.25.

As to John, I don't go short and then look for negatives. I find the thesis, do the research and then go short. Hope never enters into the process.

Mar 24 04:01 PM

[Think-About-It:]

Thanks Njord, I've been thinking about shorting BWLD for a long time but never got around to digging into the details. I view them much like I view Crispy Creams or Boston Market. Just another restaurant selling a commodity that will eventually be valued near the mean of its peer group.

However, while these stocks are in high-growth mode opening lots of new stores I would hold off on shorting them until they saturate their markets or there is a serious identifiable flaw in their business model.

Mar 25 01:39 AM

[Think-About-It:]

I just reviewed their Cash Flow statements and it is very impressive. This company can internally fund the opening of lots of new stores and cash from operations is over 2x reported earnings. I would never take a short position in this situation.

PERIOD ENDING 28-Dec-08 30-Dec-07 31-Dec-06
Net Income 24,435 19,654 16,273

Operating Activities, Cash Flows Provided By or Used In
Depreciation 23,622 16,933 14,438
Adjustments To Net Income 14,645 5,215 1,236
Changes In Accounts Receivables 375 (1,183) (1,575)
Changes In Liabilities 4,042 7,608 4,145
Changes In Inventories (473) (595) (265)
Changes In Other Operating Activities (539) (4,053) (1,221)

Total Cash Flow From Operating Activities 66,107 43,579 33,031

Mar 25 01:54 AM

[willbever:]

This is article is a prime example of why you don't make stock decisions listening to Cramer and those CNBC talking heads have to say, you do your own research.
When I was thinking of buying Buffalo Wild Wings in mid-Jan, I actually went to the establishment near my home. I talked to customers, employees and management to get their opinions. I observed the foot traffic, the place was packed. I then visited several other establishments nearby and did the same thing. I was convinced that this was a wimmer despite the price being off of its highs. I purchased it on Feb 2 at $21.77, the earnings came out on the 11th, confirming that despite the US being in a recession that both sales and revenue were up. Since then, I am up over 70% in only a 7 week time frame.
Folks, do your own investigation into these companies before you buy. This guy has probably never been in a sports bar!

Mar 26 11:24 AM