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Wings Gone Wild

11/05/2008 10:41 am EST


Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Stephen Biggar, Standard & Poor’s global director of equity research, says a fast-growing restaurant chain has more room to expand.

Buffalo Wild Wings (Nasdaq: BWLD), the growth-minded operator and franchiser of Buffalo Wild Wings restaurants, has excellent long-term growth prospects.

Minneapolis-based Buffalo Wild Wings owns and operates, as well as franchises, a chain of [over 500] restaurants serving Buffalo-style chicken wings and a variety of signature sauces, along with alternative menu items, [mostly in six Midwestern states and Texas]. The Buffalo Wild Wings restaurant concept is that of a neighborhood restaurant and bar, with the feel and atmosphere of a sports bar. Locations also offer counter and takeout service options similar to those found in a typical quick casual restaurant.

We think the company may gain market share during a recessionary economic environment, as it will likely continue its aggressive expansion plans. Furthermore, growth is likely to continue to be financed with cash from operations, and we expect Buffalo Wild Wings to remain debt-free.

Of the company's 535 locations as of September 2008, 187, or 35%, were company-operated. Restaurants are typically located near retail centers and other high traffic destinations, such as big box retailers and multiplex theaters. The remaining 348 locations were franchised. The company is focused on expansion of the chain to over 1,000 [locations], a size similar to more established bar and grill concepts such as Chili's and Applebee's.

Our five-star (Strong Buy) recommendation was prompted by the recent sell-off in the shares following third-quarter earnings that were below our expectations.

Third-quarter earnings of 25 cents a share vs. 24 cents a year ago missed our 32 cents estimate on higher-than-expected management bonuses and stock compensation. Average weekly sales at company-owned units rose 10%, which likely contributed to the higher bonuses. We cut our 2008 earnings estimate by eight cents to $1.32 a share on our projection for a 27% advance in revenues, and 2009’s by five cents to $1.60. However, we raised our three-year earnings growth rate to 21% from 20%.

We think Buffalo Wild Wings is appealing, and believe the recent selloff was overdone. The shares recently traded at 17.7x our 2009 EPS estimate of $1.60, toward the lower end of the stock's historical range and below one time estimated EPS growth in 2009, as well as at only a modest premium to peers.

We believe that Buffalo Wild Wings merits a premium valuation to peers, due to its debt-free capital structure and the still relatively early stages of its expansion plans. Assuming a weighted average cost of capital of 11.5%, up from 10.9%, we cut our discounted cash flow-based target price by $5 to $35. (It closed below $27 Tuesday—Editor.)

Risks include a steep increase in commodity costs, particularly for fresh chicken wings. A more severe or prolonged US economic downturn could cause it to moderate its expansion and lower earnings growth targets.

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