I got a few requests to take a look at the “better restaurant stock” that Timothy Lutts of Cabot alluded to in his recent article about Chipotle (CMG), and one of those readers pointed out that one of the other stocks that Cabot has been teasing, LeMaitre Vascular (LMAT), “has been looking good” … so perhaps it’s worth digging into another Cabot pick here?
What the heck, let’s get to it.
The pitch is for the Cabot Top Ten Trader service run by Mike Cintolo, which they’re selling at $397 a year these days, and it sounds like it’s mostly a short-term trading service — apparently this pick was made by them a month or so ago, here’s how Lutts introduces it:
“… my favorite growth stock in the restaurant sector – mainly because it’s the youngest — which I’ll call XXXX. This chain has 845 restaurants in 39 states and seven countries, focused on selling chicken wings with sides and fries. Revenues last year were just $85 million, and analysts expect earnings growth of 19% this year and 12% next year, but I think those estimates are conservative. And of course there’s no dividend yet.
“Mike Cintolo recommended the stock to his Cabot Top Ten Trader readers just a month ago, and they’ve already got a small profit!”
And then Lutts includes a little excerpt from Cintolo’s analysis, here’s some of that:
“‘Our core advertising is aimed at millennials,’ the CEO told CNBC last week. With good reason—nearly half of the customers who flock to XXXX’s restaurants are millennials, higher than the average at other fast casual restaurants. And because three out of every four XXXX customers order their food to go, it allows the company to keep its restaurants small, with an average size of just 1,700 square feet. That keeps costs low, as does the restaurant’s menu, which is limited to wings, fries and a few other sides. As a result, the company just reported yet another quarter of double-digit (36%) EPS growth, and is on track for earnings of $0.54 per share this year, which would be a 15% improvement over last year….”
So who is this mysterious “XXXX?” Thinkolator sez it’s Wingstop (WING), and I’ll confess that I had never heard of this company until just a few minutes ago.
This is a fast-growing chicken wing restaurant, focused on takeout, and it’s very small and growing quite quickly. I have a little trouble with stocks like this, because it’s really hard to be at all definitive about whether a company has real growth potential — particularly when you’re not in the demographic, don’t eat a lot of chicken wings, and haven’t tried the food. Is it better than all the other regional and local chicken wing joints out there? It’s not selling an experience like Buffalo Wild Wings (BWLD) is, it’s just takeout chicken wings — so where’s the excitement?
Well, it might be that the excitement comes from more marketing that’s made possible by a larger organization, or simply by the growth in store count that’s made possible by the relatively low cost of opening up a Wingstop restaurant… or maybe I’m being too critical of the fact that “every town already has a chicken wing place” — after all, every town has lots of pizza places, any of which could easily make pizza as good or better than the national takeout chains, and that hasn’t stopped Domino’s and Papa John’s from riding marketing and standardization and easy ordering into huge businesses.
What’s to like about it? Well, they do have good growth both in top-line revenue (thanks largely to opening lots of new franchised stores quite quickly, at a 100+ per year pace) and in same store sales (though same store sales are only up about 3% over prior periods right now, which is slower growth than they had last year when they went public). And it is an area, if you want to compare wings to pizza, where there might be room for a national brand and national standardization.
What’s not to like? Well, it was owned and managed by private equity before the IPO (Roark Capital), and those investors have now effectively cashed out almost all of their position as of the most recent offering to sell six million shares… and it doesn’t exactly smell fantastic that they’re cashing out of their whole position immediately after getting WING to refinance its debt, add substantially to the debt balance, and pay out a huge one-time special dividend to shareholders of $2.90 recently. Yes, venture capital/private equity investors don’t typically stick around for the long term after taking a company public… but it still doesn’t look great to have that major insider all the way out. A couple officers bought shares at $19 in the IPO last Summer, but there isn’t any meaningful insider ownership otherwise, and there has been no other insider buying — though there are a few decent non-indexed institutional investors, including Wellington Management, that have substantial positions.
WING went public in June of 2015 at $19 and was a huge hit immediately, trading up to $30 or so — the shares sold off not long after that and had a weak year for much of the time, but they have beaten the analyst estimates for four quarters in a row and the shares have now recovered back to that $30 level — thanks in part to a well-received “beat and raise” quarter announced in early August that popped the stock price from $25 to $30 almost instantly.
The growth is expected to slow down a little bit, at least according to the average analyst — the company is forecasting a high of 55 cents in earnings for all of this year, which they seem pretty likely to hit given the quarterly progression (and if that’s all they earn, it would probably be a disappointment — they’ve already posted 55 cents in earnings per share over the past four quarters through the end of June), and next year’s number is currently 63 cents per share. That’s not bad growth, but it’s barely enough for a company that’s priced this high — at $29 per share, that’s still 46X next year’s earnings for a company that’s expected to grow earnings at just about 15% a year next year on revenue growth of about 10%. You can tinker with the numbers, some analysts are higher, but you’re looking at a price/earnings/growth (PEG) ratio of at least 2.5 or 3 as I figure it… and that’s a little high for my taste.
So that rich valuation makes me a little nervous, given that I don’t have any experience with the product or the company or any sense of what their growth potential or scalability is, or any sense of whether the analysts are really lowballing numbers or not (it’s still an awfully new company without a lot of coverage, and the market cap is still under a billion dollars so it doesn’t get much attention). There has been some analyst optimism bubbling up recently, so that could be a good sign — the stock was recently upgraded and/or reiterated by some analysts, estimates have gone up, and recent price targets put out by the last couple analysts to publish are generally in the mid-$30s, so there are certainly some believers in the growth story — including Keybanc, whose analyst predicts 19% earnings growth for the next several years.
I do like the franchise model, of course, since that generates franchise fees and royalties and keeps capital requirements pretty low (WING only has about 20 corporate-owned restaurants, the other 900 or so are franchises, about 90% of which are in the US)… but there have also been plenty of companies that grew fast through franchising and lost control of the brand and the company because franchisees grew too fast, lost quality control, or ran into trouble because expectations didn’t meet reality. The company has been around and franchising for 20 years now, so it might be that all’s fine, I haven’t looked at the numbers at all closely and I’ve never been in one of their shops… it’s just another reason for me to be a little bit cautious, particularly at almost 50 times earnings and after having the major shareholder bail out at just about the same price where the shares are trading today.
And, though it’s not a huge factor at the moment, it’s also worth keeping an eye on their input prices if you like analyzing your way down to the nitty gritty — chicken wings are quite volatile, often peaking right around the time of the Super Bowl, and the pricing is an important enough input that WING (just like BWLD) will talk about it in most of their earnings releases, not unlike the way Dominos tends to focus on cheese prices. Pricing is less immediately important for WING than for BWLD, since WING is mostly franchised and the franchisees have to pay all the direct input costs (store labor, chicken wings, potatoes, etc., while BWLD is about 50% franchised), but obviously things work better in the long run for WING when their franchisees are making a nice profit.
That leaves me intrigued by the growth potential, but not buying the stock — I’ll try to keep half an eye on this one, I can see it being appealing if I can get some more confidence in the brand power and the appeal of the restaurants, and if the valuation at some point looks more appealing to me. My impression is that almost all of these rapid-growth restaurant stocks are volatile and have bad quarters from time to time (just look at Zoes Kitchen (ZOES), which was teased by a different newsletter a year and a half ago as “the next Chipotle” and did really well for a while… but then hit a rough patch this year and dropped 30%).
This is all making me really hungry, so I’ll turn it over to the Gumshoe faithful to chew on it and let us know how it tastes — If you’ve tried out Wingstop or looked at the stock, let us know if you’ve got an opinion to share.
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