COULD THIS HIGHLY VALUED RESTAURANT STOCK BE A RELATIVE BARGAIN ? – DEPENDS ON FUNDAMENTALS

We published an analysis on October 22nd, showing almost all the publicly held restaurant companies, comparing their current valuations to those before the pandemic. That chart is provided below, with prices updated to midday on 11/9. Based on the 2/15/20 (pre-pandemic) estimate of 2020 earnings, and today’s estimate of 2021 earnings, it appears that Wingstop (WING), while still carrying a very high multiple of earnings and EBITDA, is valued more reasonably today than ten months ago.

Let’s take a more complete fundamental look at Wingstop. Back on February 15th, WING was selling at $101/share. Trailing EPS, for calendar 2019, had been $0.73/share. This steadily growing franchising company was expected to earn around $0.87/share in 2021, so the P/E on forward earnings was a very high 116x. Investors obviously were valuing this small box pure franchisor, with consistent unit growth based on strong store level economics, with free cash flow providing recurring special dividends to shareholders.

The table below, from Bloomberg LP, shows the EPS trend. 2020 EPS has obviously accelerated, as a result of Wingstop’s positioning relative to the pandemic.

You can see that EPS for 2021 are estimated to be $1.43/share so that WING, at $129/share is valued at “only” 90x 2021 earnings. Adjusting that multiple upward by 5% to account for the fact that calendar 2021 is about 15 months away versus the forward 2020 normalized EPS as of 2/15/20, the comparable multiple is about 95x versus 116x on 2/15.

The question now: is WING better or worse off as a result of the pandemic, and going forward into a normalized environment at some point?

The key question in any franchising situation relates to unit level economics, which translates into unit growth and then cash flow for the franchisor. As stated in the 2019 10K, the operating model “targets an average investment of about $390k, excluding real estate purchase or lease costs and pre-opening expenses. In year two of operation, we target a franchisee unlevered cash on cash return of about 35% to 40%.” The Wingstop franchise system was growing steadily though calendar 2019. The table below shows the admirable trends, all compelling in terms of attracting investors. This is IDEAL. No wonder the valuation was (and is) so high.

Which brings us to the current situation. In the second quarter, the first during the pandemic,  for thirteen weeks ending 6/27/20, same store sales were up 31.9%. There were 23 net new openings. Adjusted EBITDA grew 54%.

In the recently reported third quarter same store sales were up 25.4%. There were 43 net new openings. Adjusted EBITDA grew 19.5%.

Predictably, the pipeline for new stores is building, with 135-140 net new openings in 2020 now the expectation, up from only 95 earlier in the year. Management stated that “our brand partners are enjoying unlevered cash on cash well above 50%….our existing brand partners make up over 80% of our pipeline.” We don’t doubt that franchisees, who were very happy at the end of ’19, with C/C returns in the area of 35-40%, are even more pleased with sales up 25-30% so far in calendar ’20.

We won’t go into the operational details other than to say that Wingstop is doubling down from an operational, marketing and real estate standpoint. International growth is a major focus, especially the expansion into China.  There is a current “regular” dividend of $0.14/share quarterly (less than 0.5% annually) but “special” dividends have been provided, with a $5.00 dividend going “ex” next week, bringing the total to over $13.00 per share over the last four years. The Company continues to carry long term debt approximating 6x trailing EBITDA, but that’s typical among franchisors and investors don’t object as long as they are getting “theirs” in a continuing low interest rate environment.

CONCLUSION:

There is no reason to expect that Wingstop’s industry position is anything but strengthened over the last ten months. While 25-30% same store sales growth will no doubt moderate, perhaps even decline a bit once a vaccine is available and dine-in activity is re-established, franchisees should continue to generate their “above 50%” C/C returns and build out their territories. We therefore view the existing consensus EPS estimate of $1.22 for 2020 to be a reasonable base  on which to build to $1.43 in 2021 and more thereafter. Investors that were prepared to pay well over 100x expected earnings for WING back in February should be more comfortable today, with an even stronger company and a slightly lower valuation.

Roger Lipton