BWLD: Company Overview (2016 10-K)
Source of Revenues Buffalo Wild Wings Inc. is the owner, operator and franchisor of 3 concepts totaling of 1,250 stores that generated $3.8B in system sales in the TTM through 17Q1. The largest concept and sole focus of this discussion is the Buffalo Wild Wings brand which competes in the casual dining bar and grill segment and consists of 1,230 restaurants (623 company, 607 franchised). Almost all units are located in the US and Canada, but 27 franchised units are located in Mexico, Panama, the Philippines and the Mideast. (The 20 stores of the other 2 brands, Rusty Taco and PizzaRev, make a non-material contribution, and the company plans to convert its 2 PizzaRev units to Buffalo Wild Wing stores in Q3). Of the $2.0B consolidated revenues generated in the TTM to 17Q1, about 95% is from company stores, with the balance consisting of royalties and fees from franchised units.
Menu and Dayparts The BWLD restaurants feature a variety of boldly flavored items but its signature offerings are made-to-order chicken wings (bone-in & boneless) served with a choice of 21 sauces ranging from “Sweet BBQ” to “Blazin’.” It also features a wide variety of domestic, imported and craft beers. Sales of alcoholic beverages represent about 20% of the average ticket. Other food items include burgers, sandwiches, salads and appetizers. To drive traffic the company hosts half price “Wing Tuesdays” and “Boneless Thursdays” as well as happy hour, a fixed price menu for game days. For the lunch daypart the company offers “Fast Break Lunch” with a 15 minute guarantee (‘or your meal is free”) for dine in guests.
Operational Model & Unit Level Economics The stores are designed to provide an immersive sports viewing experience which combines an affordable alternative to stadium attendance with the comfort and low cost of watching at home. The restaurants include an extensive multi-media system. Guests have the option of watching sporting events or other popular programs on various projection screens and televisions or playing video games. The open layout of the restaurants offers dining and bar areas that provide distinct seating choices for sports fans and families. The restaurants provide take-out service (about 20% of sales) and the company is aggressively rolling delivery service and enhancing on-line ordering capacity. The typical company-owned store built in the last 3 years is 6.1K square feet, while all company stores range in size from 3.9K to 11.2K square feet. Company stores generated $3.1M on average in the TTM through 17Q1 (up from $2.8M in 2012), while in the same period franchised stores generated $3.3M on average (up from $2.9M in 2012). At an average cash investment of $2.6M (including pre-opening expense), we estimate of cash-on-cash returns is ~22% for company stores (assuming the 5-year average store level EBITDA margin of 18.5%). In the 5 years 2012-2016 company stores grew at a 14.6% annual pace (11.2% not counting stores acquired from franchisees), while franchised stores grew at a 4.1% annual pace (7.0% not counting stores sold to BWLD).
However, the company slowed its store growth to about 6% in 2016 and 2017 after stores opened in 2015 fell short of its AUV target and cash on its 20% (year one)
cash on cash return requirement (Franchisees had already slowed growth in late 2014). Perhaps the number of franchised stores sold back to the company was an even earlier indicator of slowing performance. In the same 5 year period the company acquired 89 franchised units, 54 in 2015 alone. In any case, the company has been reviewing the pre-opening and capital costs for its new stores. This evaluation includes exploring design features to improve speed and convenience, particularly to accommodate takeout and delivery which it projects will grow to 40% of sales. The company is also looking at small format stores and designs for dense urban markets. Of these, it is furthest along on in evaluating small format stores sized at 2K-2.5K square feet with expected AUV’s of $1M-$1.5M, which, if achieved, would have better sales per square foot, and presumably better margins, than traditional stores. The company has been expecting to test a small format store in 17Q3, and says it might resume more rapid general store growth in 2018.
Company Strategy For the 5 years 2011-2015 the company grew rapidly and profitably. Unit growth CAGR of 10.0%, combined with 20 consecutive quarters of positive comps averaging 5.5% for both company and franchised units, drove revenues, EPS and free cash flow at CAGRs of 24.9%, 19.2% and 31.9%, respectively. In 2015 (if not earlier as suggested by repurchases of franchised units), signs began to appear that the brand was maturing and would have to confront a new set of challenges to sustain growth. While sales continued to grow, it was driven mostly by new store growth, as comps slowed on weakening traffic. Margin expansion also slowed. As reflected in the comps table at the end of this note, comps in 2016 grew increasingly negative for both company and franchised units throughout the year. Initially, the decline was offset by price increases in the 4% range YOY, but traffic continued falling in the 5.5% range. In 16Q4, despite a price increase of only 1.4%, traffic still fell 5.4%. Both the company and franchisees slowed store growth to 5.5% in 2016. In 17Q1 comps did return to 0.5% on positive 1.3% traffic apparently boosted by promotions, particularly “Half Price Wings Tuesdays.” However, profitability continued to fall on stubbornly high wings prices, among other headwinds. TTM store level EBITDA margins through 17Q1 fell to 16.8%, down from a high of 19.4% in 2014. Consolidated EBIT at $123.9M in 2016 was down from $138.5M YOY and EBIT margin at 6.2% was down from its recent peak of 9.0% in 2014.
At its 2016 Analyst Day, management laid out its long term plan. The plan targets a system of over 1,700 BWW units in the US and Canada and expects to sustain revenue and profit growth with continued menu innovation, investment in service improvements (eg “FastBreak” lunch, “Guest Experience Captains” and payroll increases), upgraded store formats (the rollout of “stadia” entertainment design), technology (a system-wide POS with a platform for table-top ordering and gaming devices and for online & mobile ordering apps), and loyalty programs (eg “Blazin Rewards” program launched in 2015).
During the past year the company’s strategy and performance has come under attack from activist investor, Marcato Investments. Marcato directed its criticism at almost every aspect of BWLD’s operations but its principal goals were to oust CEO Sally Smith and to remake BWLD into a heavily franchised operation by selling off company stores. Management seemed to respond with greater urgency in executing and communicating its plan. However, it strongly resisted large scale refranchising, arguing what has been successful for QSR operators has been less so for casual dining operations principally because of their greater complexity (citing Applebees as exhibit A). Still, management proposed to refranchise 10% of its stores (subsequently increased to 13% or 80 units) and to revamp the operations of another 7% of its least productive units (rather than selling for bargain prices).
As such, management outlined a plan to achieve 20% restaurant-level EBITDA margins by the end of 2018, which would surpass its 2014 peak margin of 19.4%, It expected to achieve this target despite170bps of continued industry headwinds (labor mandates & wing inflation). The plan combined cost savings of $40M to $50M with sales leverage, specifically: purchasing and COGs efficiencies (~50bps), labor savings (~150bps which includes eliminating the recently added Guest Experience Captains in most units), energy management and repair efficiencies (~20bps), refranchising and revamping poorly performing units (~90bps) and operating leverage from 1%-2% comps driven by traffic building initiatives outlined above (~110bps).
The bottom line relative to Marcato’s proxy fight was that the initiatives as described above were insufficient. Shareholders voted in Marcato’s nominees to the board at the June annual meeting, prompting the resignation of Ms. Smith and a search for a new CEO.
Aside from more aggressive refranchising than former management targeted, it is unlikely the strategy will differ much under new management, since, for the most part, the initiatives are necessary basic blocking and tackling. No doubt the franchising of company locations will be aggressively pursued, which we expect will be accompanied by faster unit growth from franchisees with expanded territories.
Though the company has levered up in the past year, it is still strong financially, with a solid balance sheet. As such, it announced a more aggressive capital strategy to increase share repurchases and possibly initiate a dividend, to be financed by higher debt as well as internal cash flows. It adopted a new leverage target of 1.5X debt to EBITDA, and in late 2016 expanded its credit facility to $500M. At the end of 17Q1, the ratios of debt to EBITDA and lease-adjusted debt to EBITDAR is 0.7X and 2.4X, respectively, well below the leverage ratios of 50% or less franchised peers. In the TTM through 17Q1 free cash flows were $129.6M (CFO: $254.3M, CapEx: $124.7M) or a FCF margin of 6.4%. Together with debt, these cash flows financed $314.8M of share buybacks in the TTM through 17Q1. Prior management said it would consider initiating a dividend. New management has not yet specified its own capitalization policy, although its embrace of a highly franchised model would be consistent with a high level of debt and aggressive share purchases.
Shareholder Returns In the last 5 years BWLD stock appreciated 77.3%, a 12.1% annual rate. The stock peaked at $205 in September 2015, retreating to about its current level after the release of its 15Q3 earnings. Since then it has traded in a range between $129 and $175..
The fundamentals at BWLD are in a “state of suspension” following the election of the Marcato slate of Directors and Sally Smith’s resignation, effective at the end of 12/31/17. Other than Smith’s resignation, and the announcement, today, of two “fast casual” versions of BWLD, apparently called B-Dubs Express, referred by us above as a “smaller prototype”, there has been no material news over the last sixty days.
The initiatives as outlined by Marcato’s Mick McGuire will no doubt be front and center, in particular the franchising of company owned stores, as well as the continued aggressive stock repurchase (possibly even more aggressive since the stock has been weak since the proxy vote). Our description of the issues, and our conclusion remains the same as we presented in late April, so we provide you with that article, as follows:
From April 28, 2017, as published by www.rogerlipton.com – Roger’s Review
BUFFALO WILD WINGS, INC. (BWLD) – STOCK DOWN SINCE Q1 REPORT, – JUSTIFIABLE?
CONCLUSION: MARCATO CAPITAL’S MICK McGUIRE IS RIGHT ! THERE IS A LOT OF POTENTIAL HERE! But there is nothing he is suggesting that the Company is not doing. Whether he gets his board seats or not, we believe the result will be largely the same: better performance, for the Company and the stock, over time.
Relative to the Q1 earnings release, the Bloomberg headlines included:
BWLD 1Q EPS $1.25, est.$1.69, 1Q co-owned comp sales +0.5%, est. +0.1%
BWLD sees FY EPS $5.45-$5.90, est. $5.77
BWLD Q1 revenues $534.76 vs. $535.35 expected
BWLD sees yr. comps up about 1%, saw up 1%-2%
BWLD sees $15M-$17M in margin savings in 2nd half of ’17
Chicken wing prices to rise 8%-10% year over year
BWLD to review restaurant operations and spending
To sell about 13% of co. owned restaurants
CNBC: earnings miss could give Marcato the upper hand
ON THE EARNINGS CALL:
Management made some of the following points, in some cases elaborating on headlines above :
New initiatives are exceeding or meeting company goals, 2 smaller format stores in test, BWLD sees delivery in 250 company restaurants by end of year, see restaurant margin of 20% in long term, comp sales may be hurt by not promoting “Wing Tuesday” deal, BWLD to change Wing Tuesday promotion by end of current quarter.
AFTER THE CALL:
CNBC : BWLD CEO pleased that comps turned positive, in Minneapolis Star: BWLD to cut $40-50 million in costs, New York Post: Buffalo Wild Wings earnings dip as wing prices soar, BWLD cut to Neutral from Outperform at Baird, PT lowered to $160, Fox Business: BWLD weathers another tough quarter, Bloomberg: BWLD margins plunge as expenses soar, cut jobs amid rising labor and wing prices, Restaurant News: BWLD faces challenging chicken wing prices.
RESPONSE OF ANALYSTS, THE MEDIA, AND THE MARKET:
You can see from the headlines and the post earnings commentary that, notwithstanding the company’s less than convincing attempt to explain the shortfalls, the clear impression was that BWLD is “struggling”. The stock selling off by 4-5% provides a good summary of the reaction, short term though it may prove to be.
The tone of the conference call was unnecessarily defensive, though understandable in light of the current proxy fight.
IF THE CLASS IS LESS THAN HALF FULL
A cynic would interpret the situation like this: “We missed the first quarter because sales were still sluggish in a tough environment. Wing prices hurt us materially and we don’t know when they will improve so we are building in a 8-10% YOY increase this year and we are adjusting the Tuesday promotion which could hurt sales. Labor was up 80 basis points, and we are adjusting the labor content by eliminating the “team captain” position, which we thought was important a couple of years ago and we are maintaining in some high volume locations. We will be reducing expenses both at the store level and G&A ($40-50M over two years to offset the higher labor and expected food costs. We are reducing the year’s earnings guidance to $5.45 to $5.90 (adjusted), which will be helped by reduced shares outstanding on our buyback.”
To be fair, the company talked about the substantial stock repurchase, the success of their operating initiatives (mobile app, delivery, service improvement, small format store plans, international franchise success, franchise interest in purchasing company stores). Unfortunately, the Company allowed the call to get bogged down with discussion of wing prices, labor issues, and the ongoing industry traffic challenges. Obviously, from the post-call commentary of analysts, the media, and the stock performance, the impressions provided were not positive, on balance.
IF THE GLASS IS MORE THAN HALF FULL
I would have put it this way, and it’s a lot more lengthy because I (as CEO of the Company) believe there is a lot more going right than wrong (listen to Howard Shultz or Ron Shaich).
“Our systemwide sales and traffic were flat to up modestly in the first quarter, which is a clear improvement over the trends of the last couple of years. Our earnings were less than expected due to short term issues and expenses out of our control such as proxy expenses. The biggest factor in the shortfall was wing prices and the wing/pound yield, especially when combined with the success of our “Wing Tuesday” promotion. We are pleased that the promotion was so well received, especially in a very competitive promotional environment but will replace this promotion with something not quite so costly. Our reduction in earnings per share guidance this year assumes an 8-10% YOY price rise to $2.06-$2.10 per pound. It ran $2.05 in Q1 and is running $2.02 at the moment. Obviously it could go either way, but the nice thing about chicken prices is that high prices most often cure themselves over a matter of just a few months. Last year they went from $1.94 to $1.72 from Q2 to Q3, then back to $1.99 in Q4. Time will tell. While we continue to cope with labor costs (up 80 bp in Q1), this is an industry wide problem, and we did at least as well as most peers in this respect. From an overall corporate expense standpoint, we believe we have uncovered potential savings, at store level and corporate, that can offset higher labor and food costs, and protect our corporate profit margin. (Forget the details, every restaurant company is doing this). We have increased the number of stores to be franchised, from 10% to 13% of our present company locations. We have seen substantial interest from existing franchisees, not only to buy stores but additional territory. We believe that our franchised new unit growth will accelerate once our franchises have more room to do so. As a vote of confidence in our long term success, we continue our aggressive stock repurchase program, amounting to $212M in just the first quarter. When our full authorization is completed, we will have retired 17-18% of our shares outstanding as of 12/31/16 in this year alone. This can obviously continue, and the Board will determine at the appropriate time what more should be done. Obviously, net debt of 1.5 times EBITDA is still relatively modest leverage, especially for an increasingly “asset light” franchisor. We have lowered our same store sales estimate slightly, from 2% to 1%, since the macro environment is still challenging and it is only sensible to be conservative in this regard. Every one of our current sales building initiatives is working, meeting, and in some cases, exceeding our expectations. Lastly, from a broad brush standpoint, the restaurant industry must provide a true “experience” to get the consumer off the coach and spend their hard earned money. We feel our venue is unique. In fact there is no other chain with 1200 units in the US that is better equipped to provide an experience to match our own. Lastly, and we will not take questions in this regard, we believe that Marcato Capital has made some worthwhile suggestions, and we feel we are in fact addressing virtually all of their concerns. Relating to our future opportunities and the proxy fight, speaking for myself, Sally Smith, I am gratified that our franchise network has given me a strong vote of confidence. I have never been more charged up to improve our long term unique positioning and also put in place many of the improvements that are obvious and necessary. Our entire team here at BWLD has tremendous pride in our past accomplishments. Some years are better than others, and the last two years has not been our best, but we feel that we have put in place some crucial initiatives during this period, and sometimes it takes a while, in the real world, for the benefits to accrue. We are just getting started in building out the Buffalo Wild Wings brand, domestically and abroad. With that, we are happy to entertain questions.” 🙂