By The Valuentum Team
Buffalo Wild Wings' Investment Considerations
• A restaurant focused on the concept of wings, beer, and sports seems like nothing special, but Buffalo Wild Wings (NASDAQ:BWLD) certainly has carved out a solid presence in this arena. With each restaurant boasting an extensive multi-media system, a full bar and open layout, 'B-Dubs' has become the place of choice for many social chicken-wing lovers.
• Buffalo Wild Wings has plenty of room to grow its restaurant base. The firm now has well over 1,000 restaurants and believes it can achieve 1,700 locations in the US, and we completely agree. We're equally excited about its new PizzaRev concept, which could do to pizza what Chipotle (NYSE:CMG) has done to burritos.
• Buffalo Wild Wings plans to grow into a globally connected brand through franchising. It has a minimal franchised presence in Mexico and the Philippines in addition to ~15 company-owned restaurants in Canada. The firm continues to seek opportunities in markets around the world and recently opened restaurants in Dubai and Saudi Arabia.
• Buffalo Wild Wings' same-store sales growth continues to outpace casual dining trends by a significant margin. Company-owned restaurants have outperformed franchised restaurants in same-store sales as well. The firm is expecting 2016 net earnings growth to exceed 20%.
• Buffalo Wild Wings continues to invest in technology to improve the guest experience and attract new demographics. Tablet ordering/payment, music and premium arcade, B-Dubs Fast Break, and B-Dubs TV are but a few initiatives.
• Same-store sales expansion continued into the first four weeks of 2016, albeit at a much slower pace than last year, but we believe the consumer marketplace will accept the 45-50 new company-owned and 42-57 new franchised Buffalo Wild Wings it expects to open during 2016 across the globe. Though we'll be keeping a close eye on food incidents, we expect traffic to remain robust at the fast-casual giant.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital. The gap or difference between ROIC and WACC is called the firm's economic profit spread. Buffalo Wild Wings' 3-year historical return on invested capital (without goodwill) is 27.2%, which is above the estimate of its cost of capital of 10.8%.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Buffalo Wild Wings' free cash flow margin has averaged about 3.3% during the past 3 years. As such, we think the firm's cash flow generation is relatively MEDIUM.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Buffalo Wild Wings, cash flow from operations increased about 50% from levels registered two years ago, while capital expenditures expanded about 5% over the same time period.
In 2015 Buffalo Wild Wings reported net cash provided by operating activities of ~$238 million and capital expenditures of ~$172 million, resulting in free cash flow of over $65 million for the year, a modest pullback from 2014 levels.
This is the tastiest portion of our analysis, so grab a wet nap and let's dig in! Below we outline our meaty valuation assumptions and sauce them into a tender fair value estimate for shares.
Our discounted cash flow model indicates that Buffalo Wild Wings' shares are worth between $152-$228 each. Shares are currently trading at ~$143, below the lower bound of our fair value range. This indicates that we feel there is more upside potential than downside risk associated with shares at this time.
The margin of safety around our fair value estimate is derived from the historical volatility of key valuation drivers. The estimated fair value of $190 per share represents a price-to-earnings (P/E) ratio of about 38.4 times last year's earnings and an implied EV/EBITDA multiple of about 14.3 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 16.8% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 24.6%. Our model reflects a 5-year projected average operating margin of 8.9%, which is above Buffalo Wild Wings' trailing 3-year average.
Beyond year 5, we assume free cash flow will grow at an annual rate of 5.6% for the next 15 years and 3% in perpetuity. For Buffalo Wild Wings, we use a 10.8% weighted average cost of capital to discount future free cash flows.
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $190 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
In the graph above, we show this probable range of fair values for Buffalo Wild Wings. We think the firm is attractive below $152 per share (the green line), but quite expensive above $228 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Buffalo Wild Wings' fair value at this point in time to be about $190 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Buffalo Wild Wings' expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $259 per share in Year 3 represents our existing fair value per share of $190 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Wrapping Things Up
Though Buffalo Wild Wings does not seem to have a special concept, it has carved out a strong presence in the space, in our view. The firm has plenty of room to grow its restaurant base, both in the US and globally. We like the aggressive expectations for 2016 net earnings growth, and the recent norovirus scare may likely be short-lived, in our opinion. All things considered, we're fans of Buffalo Wild Wings and its growth proposition. Shares are currently undervalued on a discounted cash flow basis, and we include a position in the firm in our Best Ideas Newsletter portfolio.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Buffalo Wild Wings is included in the Best Ideas Newsletter portfolio.