Wingstop (NASDAQ:WING) reported earnings Thursday evening after the market close and missed revenue consensus expectations by a small amount. This alone is not worrisome, its simply the nature of a dynamic growth company.
However, the outlook of the business however took a hit and the stock will as well. I expect WING to fall into the $15 range for the following reasons:
The market has extrapolated historical growth into the distant future which led to a company valuation of 19.8x FY17 EV/EBITDA and a free cash flow yield of less than 3%. This valuation was driven by strong comparable same store sales and an asset light franchise model. Besides the rich overall valuation investors accepted the relatively high debt load of 3.7x net debt to EBITDA ratio.
There are many factors that are working against the company and its valuation:
1) System-wide unit growth is slowing down to 13-14% for FY17 compared to >18% in both 2016 and 2015. Units opened during FY16 will help driving topline growth in FY17 to $108 million, but in FY18 growth will slow down dramatically. Decelerating unit growth of a franchise model simply show that it is likely that there is less demand to franchise locations given the bad restaurant environment and not as compelling unit economics as desired.
2) Comparable sales trends are unfavorable: SSS fell from 12.5% in 2014 and 7.9% in 2015 to 3.2% in 2016. For the first 2 months in FY17 WING has experienced -2% SSS. Management is guiding "Low single digit domestic same store sales growth" and claim to see positive trends over the last two weeks after the use of national advertising. Managing is fighting for positive SSS and that is what they have to do. However, I do not believe that such initiatives can fight negative secular trends within the restaurant industry. Similarly, I see managements theory about delayed tax refunds as a reason for their bad metric as a cheap excuse. For FY17 I expect SSS to be slightly negative.
3) Deteriorating Margins: Adjusted EBITDA margins for FY16 37.9%. I do not use managements adjustments because those adjustments include stock based compensation and other recurring items. Therefore, my figure should be slightly lower. For FY17 EBITDA margins are expected to fall below 36.5%. If SSS figures get even worse WINGs margins will fall further.
WING is a profitable company and FCF positive given its high margins and low CAPEX requirements. BUT, to own a stock valued at a 3% free cash flow yield combined with slowing unit growth and negative comps is not a wise decision.
The stock got ahead of fundamentals as it happens a lot of so called "growth companies" that are promoted by sell side analysts. Always ask yourself: Will this company exist forever and can it be replicated easily? My answers to this questions are "most likely not" and a YES".
I recommend selling the stock and buy when it trades at a huge discount to its fair value of $15.
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.