Buffalo Wild Wings (BWLD) has seen an eventful year so far. Shares have largely traded in a $130-$170 range, having shown volatile swings at times.
Shares now trade in the middle of the range despite the announcement of a sizable share buyback program and the involvement of an activist investor. Looking into the future, I see room for further growth, although I am not tempted to buy into the growth story at current levels yet.
Revisiting The Events
Buffalo Wild Wings has been a much loved growth story within fast casual dining, in part through its distinctive concept. Shares rose from just $30 in 2008 to peak at $200 in 2015. Same store sales growth and aggressive store openings allowed the company to increase its sales from roughly $300 million in 2006, to $2 billion by now, as the company avoided dilution of the shareholder base.
One point of criticism: operating margins have been stable at 7-9% of sales as the company has been unable to effectively leverage the increase in scale.
While the company reported a healthy 4.2% increase in same store sales for the overall year of 2015, momentum was fading in the final months of the year. Same store sales growth slowed down to 1.9% in the final quarter of that year, prompting shares to correct towards the $150 level. The real shocker came in April of this year when the company reported a 1.7% fall in same store sales, causing shares to sell-off to just $125 per share.
Shares recovered a bit by the end of July despite the fact that the company announced a 2.1% fall in same store sales for the second quarter. The comforting tone of management, the announcement that activist investor Marcato Capital has taken a 5% stake in the business, and $300 million buyback program send shares back to $170 again by the end of the summer.
Marcato called for focus on international growth opportunities, a transition to a 90% franchise-based model and increase in leverage, among others. If Marcato´s plans would be implemented, the investor believes that the company would be able to post earnings per share of $20 by 2021, instead of $10 under the current trajectory. It is evident that management feels the pressure, as it announced a $300 million buyback program just weeks after the investors got involved.
The Current Valuation, Still Pretty Steep
While same store sales are down, Buffalo Wild Wings continues to grow driven by restaurant openings as sales advanced by more than 15% in the first half of 2016, making the $2 billion revenue number attainable for 2016. Margins came in at 8.2% of sales in the first half of this year, down 50 basis points compared to last year on the back of deleveraging of sales.
Earnings are seen around $5.75 per share for this year, plus or minus 10 cents, which implies second half earnings of $2.75 per share. It should be noted that this is traditionally a softer period of the year for the company. With shares at $148, shares do trade at 25 times earnings already, being a steep multiple for a business which is currently reporting a decline in same store sales.
The good thing is that net debt stands at just around $125 million, including lease obligations, for less than 0.5 times annualized EBITDA. Leveraging to a 2.5 times multiple could resulted in +$500 million which could be used to fund buybacks, among others. Management has traditionally been hesitant to take on debt, as it traditionally relied on internally financed growth, but pressure from Marcato has undoubtedly played a role in the recent decision to buy back more shares.
Modeling The Future
While a $20 earnings per share number for 2021 looks aggressive, let´s work out some other scenarios. The fact is that earnings now come in around $6 per share each year, with margins trending on the lower end of their historical range of 7-9% of sales, resulting from poor current sales trends.
I assume that a 10% growth in topline sales, through openings and same store sales growth should be possible through 2021, the period which Marcato uses in its analysis. That suggests a $3.2 billion revenue number. If improvements are delivered upon, the higher end of the historical margin range of 9% should be attainable, for operating profits of $300 million a year.
Let´s assume that management would use $500 million to buy back stock, after it announced a $300 million program in August following the plan of Marcato. That plan would buy back 3.3 million shares at $150, reducing the float to 15.3 million shares. Net debt of $625 million ($125 million current net debt load + $500 million in additional borrowing) would involve interest costs of $25 million per year. That suggests that the company could report earnings before taxes of $275 million by 2021, or roughly $190 million after taking into account a 30% tax rate. Given the reduction in the outstanding share base, that works out to roughly $12.50 per share.
That is above the ¨base case¨ of roughly $10 earnings per share provided by Marcato, but lags the nearly $20 number which its uses following more aggressive growth, margin and franchise assumptions. I still think that it is pretty optimistic, as earnings per share are projected to double in this scenario in the time frame of just 5 years.
Attaching a market multiple of 18 times to such earnings would result in a $225 target. If we generously use a 20 times multiple, to reflect for ¨stable¨ franchise fees, a $250 target might be within reach. That suggests 50-60% upside from current levels at $150 for a period of 5 years, for returns of 8-10% per annum.
While I am being somewhat conservative in my growth assumptions, I am not comfortable to use much more aggressive metrics. If I would like to see more appealing potential gains of 12-15% per annum, I simply need shares to fall from current levels, before I see the real appeal.
In order to see these kind of returns I would like to buy the shares in a $120-$135 range, levels we actually saw earlier this summer. While the buyback and activist pressure will likely support the share price to some degree, I remain very patient, buying if the stock might unexpectedly test the lows of the year again.
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.