Use a Napkin: Why the Rebound in Buffalo Wild Wings Stock is a Bit Messy

Ignoring management forecasts of slowing growth, investors are hot for Buffalo Wild Wings (BWLD) again. With no relief expected from rising food costs, however, the 22% rally in the share price of the chicken-wing restaurant chain could prove short-lived.

Though company-owned restaurant sales increased 31.4% year-on-year to $220.6 million in the quarter-ending July 24, earnings grew by only 9.3% to $11.7 million, or 62 cents per share. Analysts polled by Thomson Reuters had anticipated share-net of 68 cents.

On the earnings’ call, chief executive officer Sally Smith warned analysts to lower profit forecasts, guiding net earnings growth this year to be between 15% and 20%, down from prior estimates of 20%.

Buffalo, NY-style chicken wings (boneless and traditional) dominate at this sports-bar themed chain, accounting for 39% of food sales. That said, higher poultry costs are hammering margins, according to information disclosed in the company’s second-quarter filing with the SEC: Cost of goods rose 440 basis points to 31.6% of restaurant sales, primarily due to an 82% jump in the price of traditional wings to $1.90 per pound. The company is hampered with a lower wing-per-pound yield, too, as poultry producers move production to larger birds (bigger wings doesn’t equate to “more” wings).

US Chicken Wholesale Price (Georgia Dock) Chart

US Chicken Wholesale Price (Georgia Dock) data by YCharts

Mary Twinem, chief financial officer, told analysts on the conference call that the company was “responding to commodity challenges with both menu price increases and marketing and operation strategies that [would] help lessen the bottom line impact in the near future and long term.” Specifically, the company is rolling out a newer, more diversified menu (including, on average, a 4% increase on menu prices in company-owned stores).

Investors’ initial response to the earnings miss was swift and vicious – the share price of the Minnesota-based eatery fell $8.43 to close at $70.47 a share in trading on July 25, losing 10.7% in market value. However, the recovery in Buffalo Wild Wing’s stock price, of late, would suggest a renewed confidence in management’s ability to grow both sales and net income by successfully bringing down operating costs (historically between 29 and 30% of sales).

BWLD Chart

BWLD data by YCharts

But who can blame the enthusiasts? They'e likely seen this stock chart.

BWLD Chart

BWLD data by YCharts

The company has franchised 505 Buffalo Wild Wings Grill & Bar restaurants throughout the continental U.S., but the bulk of the restaurant operator’s sales (92%) are generated at the 330 company-owned eateries. Management said comparable same-store sales at locations open more than 13-months grew 5.3%. Better numbers than the world’s top fast food operator McDonalds (MCD), which posted domestic second-quarter same-store sales growth of only 3.6% and Yum! Brands (YUM), which managed an anemic 1% gain in sales at its KFC chicken-outlets here in the U.S.

BWLD Revenue TTM Chart

BWLD Revenue TTM data by YCharts

Buffalo Wild Wing reported same-store sales growth stronger than popular casual dining chains, too, such as Bloomin’ Brands (BLMN), parent company of concept franchisees like Outback Steakhouse (2.3% growth) and Bonefish Grill (2.1% growth).

If one embraces the concept that trending same-store sales is a healthy barometer of both consumer acceptance and future growth – which management does – then a closer look suggests that top-line growth is more fragile than management and investors will admit: Eliminate menu price hikes (which contributed about 1.8%) and pre-sold gift cards (already booked into sales, another 60 basis points) – and same-store sales grew by a less-impressive 2.9 percent!

Management did not return calls specifically seeking information on the impact menu price hikes had – and will have – on comparable traffic numbers (customer visits) and per custom spending averages. Given consumer confidence remains low and unemployment remains stubbornly high, it’s probable that customers are shifting to lower-priced, value meals.

The company pays market price for its wings. CFO Twinem admitted on the recent conference call, “the traditional wing market remains high, with the price of chicken wings for the first 2 months of the third quarter averaging about $1.95 per pound (compared to last year's average price for the third quarter of $1.16).”

When will costs abate? Or, should we just change the name of the restaurant? With no cost relief on the horizon for its best-selling wings, management is aggressively marketing and promoting non-poultry inserts on its menu, such as flatbreads, burgers and pork slammers.

Short of “re-conditioning” customers to accept smaller portion sizes – four wings for the price of six? – innovation is unlikely to surmount inflationary headwinds. Recent reports issued by the USDA suggest that a combination of continued high feed costs and (anticipated) processing cutbacks could send commodity prices even higher next year. In other words, contracted costs to Buffalo Wild Wings for other meats – beef and pork – will rise further in 2013, too.

BWLD PE Ratio Chart

BWLD PE Ratio data by YCharts

Investors might want to rethink their appetite for Buffalo Wild Wings. Look at the PE ratio.With shares now trading at a premium to market leaders – 22.5 times FY 2013 estimate, compared with forward multiples for McDonalds and Yum! Brands of 15.7 times and 18.3 times, respectively – an earnings miss could clip this buffalo’s wings.

David J. Phillips is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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