With shares down -25% in the past six months (largely due to commodity/input cost inflation), BWLD is an attractive risk-adjusted investment at $71.60/share, a 20% discount to fundamental value of $90/share (20x 2013 EPS) with a risk price of $62/share (-13%) and upside value of $110/share (+54%).  At this price, the bear case appears fully priced in as investor sentiment is almost uniformly negative toward this name (e.g. 21% of the float is short.)   We believe that investors underappreciate the company’s store potential (market potential of 1.3K-1.8K stores vs 852 stores as of 3Q12), ignore the superior organic growth (~6% average company-owned SSS growth since 2001), and assume input prices (historically high and a commodity) will remain at the current levels for the foreseeable future and not normalize through 2013 (which will provide an earnings tailwind if they deflate).  For those interested in exposure to a high growth consumer concept with a large but underpenetrated market opportunity and a history of best in class performance, then a modest position in BWLD provides substantial upside potential and merits consideration.  

BWLD has been written up on VIC previously, which provides an introduction to the company and hence I will not provide a detailed business description in this posting.  However, as a quick overview of highlights of the company, its important to remember that BWLD has generated best-in-class unit and SSS growth over the past decade.  
 
                                               2000    2001    2002    2003    2004    2005    2006    2007    2008    2009    2010    2011    Average

 

Franchise Owned SSS Growth    6%    6%    2%    6%    8%    2%    6%    4%    3%    3%    0%    4%    4%       

 

Company Owned SSS Growth    11%    9%    2%    4%    10%    3%    10%    7%    6%    3%    1%    6%    6%    

The company has grown from 429 stores in 2006 to 854 stores in 2012 (13% CAGR) primarily through store expansion in the Midwest/TX region (~60% of store base).  In recent years the company has started to focus on east/west coast expansion, which is a substantial white space opportunity.  Though eating preferences are slightly different on the coasts, in the past several years the company has successfully transferred the concepts into California and many states in the east coast, and seems poised to continue to do so. 

 

Despite the company’ robust historical unit growth, the concept still appears underpenetrated.  Based on substantial diligence to analyze the market opportunity -  the BWLD total market opportunity in the U.S. could conservatively be anywhere from 1.3K-1.8K total stores in the next five years, or ~2X its current footprint.  (E.g.: Management guidance has been ~1.5K; similar concepts in the fast casual category have substantially larger store bases (such as Applebees @ 1.9K stores and Chilli’s @ 1.5K stores); and a bottom-up penetration analysis of potential store openings by states yields ~1.6K stores nationally).  Though its difficult to pinpoint the total store potential, its is easy scenarios of robust unit growth for the foreseeable future.  

Importantly, BWLD stores provide compelling unit economics (estimated at ~25% cash returns).  This has driven FCF for the company to invest in new stores and has attracted interest from franchisees (currently ~60% of the store base is franchised, with franchises paying BWLD 5% of ongoing revenues and a ~$42.5K upfront fee).  The company has a unique, branded concept (premium bar, HDTVs, high customer food satisfaction) with low menu prices (estimated average meal is -10% cheaper, or -$1.50/meal, than competitors largely due to high concentration of low-cost chicken-based offerings and superior operations) which has proven to be a compelling value proposition for the typically suburban customers.  In addition, many long-term secular trends in the restaurant industry favor BWLD (e.g. long-term trend of consumers toward dining-out; shifting consumption towards branded chains continues at the expense of independent operators; consumers trading down to faster service and lower-priced ticket offerings.) Furthermore, a superior concept, targeted national advertising, disciplined site selection, have all resulted in company’s SSS growth that have led (or been near the top) of its comp group (average of 6% company owned SSS growth since 2000, no SSS declines since 1Q03).

However, 39% of revenue generated is from chicken-wing food sales (21% from alcohol, and 40% from other food products).  As a result, the rise in chicken wing prices (from ~$0.88/lbs in June of 2011 to ~$1.80 currently – based on the USDA pricing) has impacted earnings and led to menu price increases.  This has undoubtedly been a headwind to BWLDs earnings and will continue to remain so. 

 

However,  many investors remain myopically focused on the rising protein prices, and ignore the continued, underlying revenue growth at BWLD.  (In 1H2010, a similar phenomenon occurred – shares fell to the mid-$30’s on concerns of chicken wing prices – over the course of the next two years, the company continued to growth, chicken prices normalized, investors refocused on the growth story and shares rebounded to ~$95, for a 2-3X return.)  Its important to remember that chicken wing prices are a commodity and have been volatile in recent years.  Though demand for chicken wings are rising, chicken wings still behave like most commodities with supply expanding in periods of high prices and contracting durring low price periods (i.e. farmers increase production when prices high, resulting in subsequent price deflation and conversely, when prices are low they decrease production until prices normalize).  This will be a continued concern for BWLD, and unless you view chicken wing prices as entering a sustained period of high prices, the current focus on wing prices provides an opportunity for patient investors that are confident in the long term growth story to buy undervalued shares.  Finally, its important to know that since 1Q12, chicken wing prices have remained relatively flat and do not appear to have increased materially; based on a quick look at recent prices it appear that the historical average for chicken wing prices appears to be closer to ~$1.20/lbs).

Certainly, its hard to get "too" excited about BWLD’s earnings multiple at >21X PE (or free cash flow yield of <2%), which certainly does not appear cheap on a relative basis (and won’t be interesting to many investors). This is a controvercial stock and heavily shorted, though a I would caution investors against a short position in this high-growth name for many reasons (e.g. the company/concept is not broken, no liquidity issues, clean accounting, long-term management team, etc.).  At the current valuation, it appears that the bear case has been fully factored in.  In fact, if you don’t believe that the company will ever grow new units or have SSS growth similar to the past, and you simply value the existing store base, it appears that the current valuation provides a cheap option on new store growth potential: the existing store base appears worth $62/share assuming no unit growth, SSS growth moderates to 3%, chicken prices/gross margins never improve, and you exit at 6.5X EBITDA).  

 

Certainly this is a volatile stock and there may be an opportunity to pick up shares for even cheaper in the next few months if protein prices continue to rise, but its not hard to see scenarios where the company continues to deliver 10%pa unit growth, SSS of 4-6%, chicken prices normalize and margins improve 100bps, and the company trades at >$100/share on 25X EPS of $4.20.  (As long as BWLD is considered a high growth name, it will trade in-line/at a premium to high growth peers at 22-25X PE, 8.5-10X EBITDA, or at a +2X EBITDA premium to casual dining peers.)  We believe that shares are worth the risk and that current pessimism will be re-evaluated by the market in the next 6-12 months as BWLD continues to expand revenue as management penetrates a large market opportunity, SSS remains robust, and normalization of protein prices will allow investor to refocus on the compelling growth story.  


Risks
- Short term increases in protein prices which could pressure margins or impact SSS growth if company is unable to pass on inflation

- BWLD’s concept, which has been successful in the Midwest/TX may not transfer to the east/west coasts (however, BWLD has had a foothold in both coasts in recent years and appears to be a successfully expanding)
- U.S. dining trends in the past 10 years have shifted to more healthy-lifestyle alternatives which could weaken the customer experience at BWLD stores
- Macroeconomic headwinds continue (restaurant sales are highly correlated with consumer income and the broader economy.  However, BWLD has been well positioned in the recession by offering a lower-priced alternative.)
- Barriers to entry in the restaurant category are low     

Moderation in chicken wing prices
SSS growth continues
Unit growth continues