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Alexander Nicolau

BWLD AT A GLANCE

P/E ► 34.3 HIGH EV/EBITDA ► 15.7 HIGH ROA ► 8.4% AVG ROE ► 12.3% AVG Debt to Equity ► 0.494 LOW Current Ratio ► 1.65 HIGH

 

 

 

 

 

 

Buffalo Wild Wings, Inc. (NASDAQ:BWLD) operates a series of sports bar restaurants across the U.S., but with heavy concentration in Ohio. The company's market share has grown at an average rate of 27% for the last five years, and operating income growing at 39% in the same period.^[1] However, BWLD's earnings growth slid at the end of 2007 as business at its restaurants decreased with the slowing U.S. economy.

Chicken prices are rising because corn, which is a major ingredient in chicken feed, has become more expensive. Buffalo Wild Wings is sensitive to the price of chicken feed - a 10% increase in the price of chicken wings would increase the company's cost of sales by $2.1 million, no small consideration for a company with $35 million in net income in 2007.^[2] BWLD signed a contract to pay a fixed price for chicken wings, but this agreement expired in March 2008.

As a sports bar, BWLD's sales are tied to professional athletics' calendar - BWLD's earnings have generally been lower during the second quarter, when there are few big sports events.

Business Overview

As of December 30, 2007 BWLD operated 161 and franchised an additional 332 restaurants in 37 states^[3]. The firm's principal business is the casual restaurant business. The bulk of their revenues come from restaurant sales at their company-owned restaurants (89%). Food and nonalcoholic beverages accounted for 73% of restaurant sales, with the remaining 27% coming from alcoholic beverages. The menu item with the highest sales volume is chicken wings at 23% of total restaurant sales. Franchise fees and royalties are 11% of revenues^[4]. As you can see from the chart below this approximate 9:1 revenue relationship has been maintained over the past 5 years.

Over the past 5 years, revenues have increased at an average annual rate of 27% while operating income has increased at an average annual rate of 39%. These extremely high growth rates are mostly due to the large unit growth rates of BWLD. Furthermore, cost of goods sold has fluctuated somewhat over the past five years but has maintained an approximate level of 30% of restaurant sales. The increasing operating margins over the past 5 years can be attributed to the fact that revenues have grown faster than the cost of goods sold^[5].

One of the key measures used by BWLD to measure the likability of their restaurants is same-store sales growth. As you can see from the chart below, 2007 broke off the track of increasing same-store salesgrowth as company-owned same-store sales growth fell from 10.4% in 2006 to 6.9% in 2007 and franshised same-store sales growth fell from 6.1% in 2006 to 3.9% in 2007. This is primarily due to the fact that their new product mix which was intended to increase sales growth, was offset by increased chicken wing prices in 2007. This also indicates that much of BWLD's revenue is coming from increased unit growth (50 stores in 2007), as opposed to same-store sales growth^[6].

For profitability comparisons between BWLD and its' relvant industry, sector, and index please see the chart below:

Key Trends and Factors

Chicken wing prices are highly volatile which leads to uncertain operating earnings

Since chicken wings are the largest selling item on BWLD's menu, accounting for 23% of restaurant sales, any changes in chicken wing prices have dramatic implications for BWLD's cost of goods sold. Fresh chicken wing prices were $1.28 per pound, 9% higher than the $1.17 they averaged in 2006. Every 10% increase in fresh chicken wing costs would have led to an increase in restaurant cost of sales by approximately $2.1 million for fiscal 2007. Below is a chart detailing the price of chicken wings per pound on a quarterly basis. As you can see, over the course of 2007, wing prices declined and at the end of 2007, the price per pound levels off at 1.23 per pound. This is due to the fact that BWLD entered into a year long agreement in March of 2007, ending in March 2008, whereby they arranged for an unwavering price of $1.23 per pound of chicken wings^[8]. They have been unsuccessful in obtaining longer term agreements with any of the available suppliers. This exposure to chicken wing price fluctuations threatens their future earnings especially in an inflationary environment. However, the lower cost of chicken wings in the latter quarters of 2007 allowed for the widening of operating margins. In addition, chicken wing prices have been trending downward below $1.23 in 2008. Moreover, chicken wing prices are largely dependent on corn prices; corn is the primary food source for chickens and as such, the increased costs in feeding chickens is incorporated into the cost of chicken. So, the increases in corn prices during 2006 and 2007 have led to chicken wing price increases during the same period^[9].

Poor economy weakens demand

During periods of weak economic growth, discretionary spending tends to taper off leading to decreased sales at casual dining restaurants and fine dining restaurants. Since the latter part of 2007, thoughts of recession have been looming, and this would have a negative effect on BWLD as people begin to cut spending. On top of that, gas prices have increased, all of which means that people have curtailed their discretionary spending habits. The decreased demand has led to lower sales in the last quarter of 2007 as compared to the last quarter of 2006, and could cause lower sales throughout 2008. In addition to a decrease in discretionary spending and increase in gas prices, the housing market troubles have led to tighter lending standards meaning that it will be harder for potential franchise owners to finance their franchise purchases^[10].

With low market penetration, growth opportunities are abundant

As of April 2008 there were 493 Buffalo Wild Wings restaurants in 37 states, and 86 are located in Ohio. This leaves the opportunity for nationwide growth. In 2007 BWLD opened approximately 50 new restaurants which has accounted for the majority of their revenue. Unit growth was about 11%. In 2008, management's goal is 15%. The unoccupied 13 states represent potential new markets for BWLD; however, BWLD is concentrated on developing existing markets in order to establish the BWLD brand. The firm offers substantial discounts for opening franchises in markets in which they would like further development.^[11]

Commodity price increases, in addition to chicken wing and corn price increases, put pressure on operating margins

With increases in commodity prices during 2007 and the first half of 2008, BWLD's cost of sales has risen significantly, which puts pressure on operating margins.^[12] While BWLD's core products are chicken wings, as a casual restaurant it does offer many other menu items. As a result, it is widely exposed to the increase in the prices of many different foods, from bread to ketchup. Over the last 3 years, global food prices have increased 83%. While some of these higher costs can be passed onto customers at Buffalo Wild Wings restaurants, if the menu becomes too expensive customers will seek other options.

Increasing labor costs will hurt margins

In 2007, the federal government along with many state governments passed bills to raise both federal and state minimum wage standards. The federal bill called for a $.70 increase by the end of the summer of 2007, another $.70 increase by the end of 2008, and a minimum wage of $7.25 by the summer of 2009. State minimum ware requirements vary state by state but they too have gone up^[13]. Since many restaurant employees are paid minimum wage or less due to the expectation of tips, the increased minimum wage requirements will force BWLD to pay their employees more which will lead to increased operational costs and ultimately, tighten margins.

Seasonality of the business affects revenues

Operating as a sports bar, BWLD is largely sensitive to seasonal factors, most notably, the number of big sports events. It is for this reason that second quarter sales have generally been lower than other quarters'. In addition, this sensitivity to sports seasons leaves them susceptible to slower business when, for example, the teams in the Super Bowl are of little interest to the customers of BWLD restaurants.

Competition

BWLD competes primarily with local and regional sports bars and casual dining and quick casual establishments, as well as with quick service restaurants such as wing-based take-out concepts. Many of BWLD's direct and indirect competitors are well-established national, regional or local chains^[14].

Main competitors include:

• Brinker International (EAT)- Operates casual dining restaurants such as, Chili's Grill & Bar, Romano's Macaroni Grill, On The Border Mexican Grill & Cantina, and Maggiano's Little Italy, in 49 US states and several countries.
• Ruby Tuesday (RT)- Operates casual dining restaurants under the Ruby Tuesday brand name in the U.S. and internationally.
• BJ's Restaurants (BJRI)- Operates casual dining restaurants in the U.S. under the names, BJ's Restaurant and Brewery, BJ's Restaurant and Brewhouse, and BJ's Pizza and Grill.
• Cheesecake Factory (CAKE)- Operates full service and casual dining restaurants in the U.S. under the names, The Cheesecake Factory, Grand Lux Cafe, and The Cheesecake Factory Express.
• California Pizza Kitchen (CPKI)- Operates casual dining restaurants in the U.S. and internationally under the names, California Pizza Kitchen, California Pizza Kitchen ASAP, and L.A. Food Show.
• Applebee's International (APPB)- Operates the largest casual dining restaurant chain under the name Applebee's Neighborhood Bar and Grill in the U.S. and internationally. It was acquired by IHOP in 2007.
• Darden Restaurants (DRI)- Operates restaurants under the names Red Lobster, Olive Garden, Bahama Breeze, Smokey Bones, and Seasons 52 in the U.S. and Canada.
• Hooters Restaurants (privately-held)- Operates casual dining restaurants in the U.S. and internationally. It is known by many for it's chicken wings.

References

1. ↑ BWLD, 2007 10-K, Item 7, p.23
2. ↑ BWLD, 2007 10-K, Item 7A, p.31
3. ↑ VWLD, 2007 10-K, Item 7, p.20
4. ↑ BWLD, 2007 10-K, Item 7, p.21
5. ↑ BWLD, 2007 10-K, Item 7, p.23
6. ↑ BWLD, 2007 10-K, Item 7, p.23
7. ↑ Buffalo Wild Wings, Inc. Ratios-Reuters
8. ↑ BWLD, 2007 10-K, Item 7A, p.31
9. ↑ Corn Prices Near Record High, But What About Food Costs?
10. ↑ Eateries make adjustments as weak economy bites into sales
11. ↑ BWLD, 2007 10-K, Item 7, p.24
12. ↑ Buffalo Wild Wings and Chipotle Hit by Food Inflation
13. ↑ Minimum Wage Hike Approved
14. ↑ BWLD, 2007 10-K, Item 1, p.8