Seeking Alpha

Wingstop: Much Like The Chicken, It Will Not Fly

|
About: Wingstop Inc. (WING)
by: Mauro Solis
Summary

The complexity of the chicken should not be underestimated.

Without vertically integrating the business, the moat is scarce.

The company is severely overvalued, and there is little chance it will live up to the expectations.

Wingstop (WING) is expected to deliver incredible revenue growth next year, and the market estimates it will be growing very well in the following years. Investing in the company presents an absurd risk-reward proposition with modest downside and horrible upside potential, and as for its price, it is dreadfully overvalued with tiny dividends.

Source: Flickr

Wingstop is a mid-cap company with a market cap of about $2.6 Billion with decent financials. Its future will be marked by the growing number of competitors, which will be met by a small moat.

Talking Chicken

Chickens are a growing source of food in America, and the market is as close as it gets to an oligopoly. Chicken prices have risen for the past few years and are expected to keep growing as regulation, and environmental impacts are priced into the product. Chicken wings might be more impacted by the price fluctuations since chicken wings are increasingly popular, and there are only two wings on each chicken.

Chickens are designed to grow fast and grow where it counts. Improving chicken wings size and quality is not the goal of the chicken producers, and Wingstop is not big enough to engineer and reduce the cost of chickens and chicken wings it gets.

As the market shifts towards organic or free-range chicken, Wingstop will have to decide how it sources its chickens. If it will keep its prices low and face the risk of backlash over the environmental impact of the chickens it buys or switch to organic or free-range chicken and increase its prices and possibly growth prospects considerably.

As the video above shows, Costco (NASDAQ:COST) is vertically integrating its chicken operations precisely to control the costs and narrative of the chickens it uses. Unfortunately, Wingstop has much less maneuverability and much higher exposure than Costco. The majority of its products are based on chicken, and chicken wings could be the most affected part of the chicken when it comes to price.

Chickens are serious business. Wing Stop does not have a substantial moat when it comes to maintaining its most essential raw material prices, and any moat they have is on the flavor and recipes of their chicken wings. The increasing competition and the easiness at which new and arguably better chicken wing recipes appear on the market prove that Wing Stop has little to no Moat.

Valuation

In the past five years, revenue growth has oscillated from 14.9% and 45.9%, and the trend has been decreasing. The prediction estimates average revenue growth of 14.5% compared to the past average of 23.4%. The gross margin has had a minimum, and a maximum of 65.3% and 76.3%, and the tendency has been growing. The prediction estimates an average gross margin of 76.7% compared to the past average of 70.9% and G&A as a percentage of revenue of 54.9% compared to the past average of 42.9%. With the above considerations, we have the following chart.

Source: Author´s Charts

These approximations are in line with the market expectations for Wingstop in the next couple of years, as the image below shows.

Source: Seeking Alpha

I like to use Peter Lynch's ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is.

Source: Author´s Charts

This valuation does not take into account the assets and liabilities of the company. The growth considered in the valuation is the average yearly growth of the next years. While the valuation considers the dividend to estimate the fair price, it is not taken into account for the average yearly return.

With this valuation, arguably, the stock is at worst overvalued by 85% and, at best, overvalued by 81%. So the stock is overvalued

Source: Author´s Charts

Constructing an adjusted Beta Pert risk profile for the long-term prospects of the stock, we can calculate the risk profile for the company

Source: Author´s Charts

The risk profile shows there is a 93% probability that Wingstop will ever trade at a lower price than it is today. Considering the potential downside, upside, and the likelihood of each, the statistical value of the opportunity of investing now is of -26.8%.

Let's explain in greater detail the statistical value of the opportunity to invest in a company. The statistical value is the sum of all the possibilities of an event or a proposition, multiplied by their respective output.

Betting heads on a coin flip, where if you win, you will get 100% return, but if you lose, you will lose 100%, has a statistical value of 0%. If someone were to bet an infinite number of coin flips, they would end up with the same money they began with.

https://static.seekingalpha.com/uploads/2019/7/3/48398079-1562182369191027.png

On the other hand, if the odds of the coin flip were heads, you win 200%, and tails, you lose 100%, the statistical value of the bet would be 50%.

Even when we take into account the dividends of the company, the prospects continue to be disappointing.

Conclusions

The core business of Wingstop is favorable, but the current price is horribly overvalued, and even if the growing number of competitors does not push Wingstop to the top bottom of the estimates, it might not give a payback big enough to justify holding the stock.

Chickens have been the subject of so much speculation. Even Billions made one of its episodes about it. The future prices of chicken will make or break the company, and with little control over those prices and a severe overvaluation, it is unwise to buy the stock.

If there is anything in this article, you agree or disagree with or would like me to expand further on; I would sincerely appreciate you leaving a comment. I will address it as soon as possible.

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.