Description

Push is coming to shove and we are seeing that WING really is exposed to franchisee economics.

SHORT Wingstop (“WING” or the “Company) a perceived powerhouse showing signs of weakness. At ~90x ‘22 EPS and a sub-2% FCF yield (conservatively), WING has a long way to fall before it has any support from valuation.  

Heffer504 posted a great write-up on the WING short in September 2018 which has a deep comment section. Leo11 also wrote it up in October 2016 as well. 

I think this idea is incredibly timely given the recent developments discussed below. For the sake of brevity, will avoid rehashing elements of the short thesis which have been discussed in detail in the precedent write-ups/comments. These are well understood by this point. Instead, will focus on what I believe is new/incremental: 

1: Unexpected departure of long-time CEO.

Monday after market close, WING put out a press release announcing that long-time CEO Charle Morrison resigned as CEO and from BOD a few days prior to join a private salad concept. WING appointed Michael Skipworth as CEO and to replace Morrison on BOD. The release did not describe the reason for the departure. Investors likely expected to hear more details on the call scheduled for the same day. They didn’t. The call was truly bizarre, outside of reading prepared statements, Morrison and Skipworth did not provide any incremental information and did not take Q&A. Why they held a call in the first place is a good question.

Morrison was only 52, had led Wingstop for 10 years including through its IPO and was well regarded by the investment community. WING has set out grand ambitions for growth and has certainly executed well since the IPO. So why would Morrison leave now?

The CEO departure follows several other executive departures over the past few years. Ordinarily, this wouldn’t be as big of a red flag, but WING has been such a high flier that these moves don’t jive with the implied market expectations.

The timing is most curious. We are approaching March Madness and just finished the Super Bowl, both seasonally important periods for wing consumption. And WING is facing tough prior year comps as benefits from Covid fade. 

While Morrison’s exit may be drowned out by CEO departures at DPZ and SBUX, I think this one is much different than the others.

2: Recent recap highlights flaws in assigning astronomical multiples to capital-light business model.

The special dividend associated with the recent securitization was disappointing at $4 per share. I suspect some were also curious about the use of funds not distributed. 

In press release announcing closing of securitization and special dividend, WING said: 

“...strengthens our liquidity position and positions us to support our strategic growth initiatives to provide best-in-class returns for our Brand Partners…”

I believe this has/will lead to a realization that WING’s capital-light business model does have exposure to franchisee P&Ls (higher wing prices and labor challenges).

From Cowen report 3.10.22:

“WING's elevated cash balance is directed toward a solution to help structurally mitigate bone-in wing price volatility. The aim is to improve franchisee economics while committing to a capital-light business model. Among a litany of options, this suggests to us WING is looking to be cash-rich while structuring a strategic partnership, joint venture or equity stake.”

“We caught-up with WING management after the completion of the new $250M securitized financing facility (see initial takeaways here). Our conversation gave us a better appreciation that the ~$130M increase in unrestricted cash is largely due to supply chain efforts to structurally mitigate the volatility of bone-in wing prices. Said differently, Wingstop is taking the opportunity to be cash-rich and explore a variety of actions that will allow the brand to be more in control of its own destiny with bone-in wing prices, to build on the strength of franchisee profitability while committing to an asset-light business model. In essence, the company is looking to balance a 3-legged stool between vendors, franchisees and investors. Encouragingly, bone-in wing prices of $2.14/lb are well below $2.60/lb at the time of the February 16 4Q21 earnings call.”

“We could envision this resulting in a JV, strategic partnership or equity investment, though nothing is imminent or decided. Should the company no longer need the cash, we would expect it to be returned to shareholders through a special dividend or share repurchases, depending on market conditions. Wingstop currently has no share repurchase authorization.”

Higher wing prices have stomped on store level margins. Company-owned SL margins were ~15% in 4Q21 and franchisee margins likely much worse. 

3: Lapping several years of heady SSS growth (driven by delivery and pricing) 

SSS have been on fire for several years, but slowed throughout 2021 on very tough comparisons. I think the drivers here are well discussed in prior write-ups and threads. The key dynamic is what follows in the next bullet, WING’s core demos won’t be able to afford further price increases (from both wing costs and paying full freight for delivery).

4: Sharply declining purchasing power of core customer demographic 

The discretionary spending power of WING’s target customer base has been incredibly strong over the past three years. Many of the drivers of that spending power are ending or in reverse. Stimulus is over, food and energy prices are going to squeeze spending from elsewhere, student debt moratorium ending, etc.

5: Delivery business model hits the skids (losing subsidy from DoorDash as their economic model breaks down without endless VC funding)  

I don’t think it is well understood how much the WING/DoorDash partnership benefitted Wingstop. And I suspect Wingstop management/IR played a role in this lack of understanding by not providing fair disclosure on some aspects of the deal. 

DoorDash likely provided not just promotional delivery, but ad support as well. And the price markups on delivery orders These went a long way in explaining the SSS spike WING saw from 2018-2021. 

6: Competitive concepts continue to proliferate (virtual brands, recent BWW announcement)

WING hasn’t had much competition over the years and so far they have held up well. But new competitors keep popping up and I don’t think this can be ignored. Meanwhile, re-opening will push some of business they captured during Covid back to prior venues. 

Even if these concepts have only a marginal impact on WING’s sales, they have continued to apply pressure to industry-wide wing prices.

Summary 

While comps held up well in 2021, WING has posted disappointing earnings several times over the past few quarters, mostly driven by elevated expenses and worse than expected margins. The stock typically recovered after the initial sell off. While WING is down sharply from highs, it has held up much better than other Covid beneficiaries. And the valuation still is a head scratcher.  

Some might push back on using P/E, EV/EBITDA or FCF yield, arguing the Company has a huge growth oppty. and is investing appropriately. But despite stated 50%+ cash-on-cash yields and payback periods in the months, WING’s current financials aren’t seeing a substantial impact from growth investments either through P&L or cash flow statement, so these valuation metrics are completely appropriate. 

Note: I am using the adjusted (inflated) historicals and projections (per Baird) throughout in order to be conservative. 

Executive Turnover/Management

In hindsight, Charlie’s departure seems less unexpected following the promotion of Michael Skipworth from CFO to President/COO last year. 

I have never thought very highly of WING’s management team although they deserve to be commended for their focus and success. One of the main reasons is that I get the feeling they aren’t providing investors with a forthright understanding of the business. They haven’t been open and honest about a number of critical aspects of the business (impact of delivery on comps, pricing, store economics, international business, franchisee base). I get that executives need to “sell” their company to multiple constituencies, but in my opinion to be a great company you really need to have executives that shoot it straight. It goes a long way. 

One example is during the height of Covid, instead of putting out an 8-K and updating all investors on an equal level, WING instead had several brokers host calls where they discussed what was happening to their business. A number of comments made on these calls by management about the franchisee base, etc. were not accurate/misleading in my opinion. Outside the scope of this write-up but can elaborate more if anyone wants to dig in.  

Business Model 

In my opinion, long/short investors can generate considerable alpha from the marginal changes at companies (and the market perception of them). Great to good, bad to mediocre, etc. Wingstop is perceived as a great company and one of the top restaurant growth chains on the planet. And its valuation reflects this belief. 

Think it would come as a big surprise if you told someone outside of finance that Wingstop was one of the most highly valued restaurant operators in the country. The operating model is efficient, but there is very little that you’d consider great about the brand or food. You could point to Dominos (“DPZ”) as a counter to this, arguing food just needs to be OK and don’t need a brand that lives in the hearts and minds of consumers if you optimize the distribution, etc. But WING and DPZ aren’t very similar. Aside from a much different food category, DPZ owns its delivery.  

The Bulls say WING’s 100x P/E multiple is warranted because of scarcity of growth oppty in restaurants (which makes no sense from valuation perspective but does provide a technical/flows explanation for the ridiculous valuation). 

Everyone seems to agree that as a franchisor, WING has no exposure to the restaurant P&L. This idea has gained wide acceptance as this business model has taken off in the last 5-10 years and propelled several names to absurd valuations. Pumper Jaffray even calls franchisors a new asset class. But I believe this enthusiasm is misguided because you cannot separate the economics of the franchisee/franchisor indefinitely. It might not matter over the short-term, but eventually if the franchisees aren’t making money, WING won’t either. 

John Hamburger gave a great speech on this topic at a Grant’s Conference in 2018. 

In a presentation titled "Why Rising Interest Rates and a $15 Wage Will Upend a Decade of Financial Engineering in the Restaurant Business," John Hamburger, president of the Franchise Times Corp., had this to say: "I'm here to tell you this Shangri-La doesn't go on forever. You can't have one side of the franchise contract getting fabulously rich while the other side faces these headwinds alone. The concept of a moat around the franchisor is a myth. That somehow a brand can separate itself from the unit-level economics of its franchisees is not grounded in reality."

https://www.grantspub.com/files/presentations/John%20Hamburger%20Spring%202018.pdf

Store Margins

WING’s financial model has relied on the simple menu, minimal labor requirements (easy food prep) and compact footprint (80% delivery/take-out, lower real estate costs). 

The spot price of jumbo bone-in chicken wings rose 70% in 2021 and represents 65% of product costs for WING. Over the past several years, the Company has tried to alleviate shortages by contracting out with suppliers, starting a virtual concept called ThighStop and pushing boneless chicken wings.

Wing prices are a problem because there is a limit to how much pricing consumers will accept. And franchisee margins have been getting hurt badly. Of course, the Bulls are quick to list declining wing prices as reasons for optimism (despite rarely acknowledging higher wing prices are a significant risk). 

Domestic Expansion

WING has done well in several core markets with a solid base in TX, CA, FL and IL.  

Reaching the Company’s unit growth targets will require more than fortressing, they will have to expand into new markets which can be very challenging. Specific to WING, the new markets will require franchisees to adapt the model (e.g., more expensive real estate).  

International Expansion

Despite an ambitious 3,000 unit international growth target, even before Covid WING’s international business hadn’t been gaining traction. At year-end 2019, roughly 65% of the international locations were in Mexico. 

WING’s international business was significantly impacted by Covid as the restaurants relied much more on in-person dining. The Company provided support to these franchisees during 2020, but in 2021, WING pulled out of three countries. International comps have been negative but aren’t disclosed. Last year, WING paid $4.2mm to acquire debt issued by its UK master franchisee (Lemon Pepper Holdings). The investment resulted in WING acquiring 20% of the business. 

I think it is important to note that the entire business concept is different for international locations versus domestic. While Mexico and Canada may be similar enough to the US to work, Europe/Asia will be much more difficult for a variety of reasons including logistics, local food culture and real estate.  

Management has hinted at a China JV. Unclear if this will require investment of some sort. I think this is one of the last things left to get the Bulls excited. Not optimistic on their prospects here.

In short, I do not believe WING’s 3,000 unit target for international is realistic or feasible. And the valuation depends on this.  

3.14.22 Conference Call

Operator

Good evening, ladies and gentlemen, and thank you for standing by. Welcome to the Wingstop Inc. Business Update Conference Call. (Operator Instructions) Please note that this conference is being recorded today, Monday, March 14, 2022. On the call today are Mr. Charlie Morrison, former Chairman and Chief Executive Officer; and Mr. Michael Skipworth, President and Chief Executive Officer. I would now like to turn the conference call over to Mr. Charlie. Please go ahead.

Charlie Morrison

Welcome, and good afternoon. This afternoon, we issued a press release announcing my resignation as Chairman and CEO at Wingstop and the appointment of Michael Skipworth as President and CEO. After nearly 10 years leading this tremendous brand today is a bittersweet moment for me. However, I have this opportunity to hand over the reins to a talented and exceptional leader. Michael has been by my side as my esteemed colleague and trusted partner and friend for the past 8 years. We've accomplished great things together. When I look back on my time here at Wingstop, our strategy of strengthening best-in-class returns, scaling the global brand and accelerating growth has remained consistent. At the foundation of that strategy is people, which is where we have focused our time as we build our bench of talent for Wingstop's next phase of growth.

The Board of Directors' immediate decision to appoint Michael as CEO is a testament to our focus on people. I truly believe we have some of the best and brightest minds in the business right here at Wingstop and know the team Michael has at the helm of this company, is an industry-leading team that will further propel this business forward. Great things are in store for this brand, and I couldn't be more honored to turn the keys over to a phenomenal leader and friend.

Michael joined Wingstop in 2014, and together, we took the brand public in 2015 with one of the most successful IPOs in the history of the restaurant industry. Since our IPO, our 5-year stacked domestic same-store sales is nearly 50%. New unit development averaged a growth rate of 11.5% annually, system-wide sales growth averaged 19% and adjusted EBITDA growth averaged 20%. We achieved our 18th consecutive positive same-store sales growth year with Wingstop and Wingstop has an incredible amount of momentum behind the brand. Over the years, you all have forged personal relationships with Michael as our CFO, COO and now our CEO. I address you today knowing the future this company couldn't be in better hands. And although I'm moving on from Wingstop, I will remain one of the brand's biggest cheer leaders, as I watch Michael and this talented team scale the company for its next inflection point of success. I'd now like to turn the call over to Michael Skipworth, Wingstop's President and CEO, for a few comments.

Michael Skipworth

Thank you, Charlie, and thank you all for joining us today. As Charlie transitions to his new opportunity, I found myself reflecting on the past decade he's had with our brand. I have mixed emotions as we bid farewell to Charlie and I transition into my new role. Not only has he been a great mentor and business partner, we've also developed a close friendship over the years. We've experienced a great deal together over the past 8 years, and I want to thank him for the opportunity he provided me to join this tremendous brand.

When Charlie joined in 2012, his focus was on scaling the brand for rapid growth. At the time when he arrived, technology was not a priority. Cash registers and fax machines were used to fulfill orders and digital sales accounted for a marginal percentage of our business. He began investing in talent and built his team for the growth he knew would come through the execution of our strategies. He maintained the simplicity of the model, driving best-in-class returns for our brand partners and pivoted our business towards a technology-forward company.

Fast forward, our AUVs are $1.6 million and digital sales mix now sustained greater than 60%. We're well on our way to executing against our stated goal of digitizing 100% of transactions. In March 2020, our world dramatically changed. No one ever prepares their business for a pandemic, but Wingstop was ready. The resiliency of Wingstop was proven once again as domestic same-store sales increased 21% in 2020, and we opened a record number of restaurants. Many thought it would be challenging for us to lap 2020's performance, but we did it and catapulted straight into our 18th year of consecutive same-store sales growth. It was this performance and resiliency that gave us the confidence to increase our global restaurant target to 7,000 plus.

I truly believe the best is yet to come. The momentum we have behind this brand is stronger than it's ever been. We entered 2022 with a record development pipeline and wing deflation on the horizon, which positions us for the potential of another record year. We also have the talent in place to take Wingstop to the next level. I have the utmost confidence in my leadership team and know our bench of talent throughout the organization supports our growth aspirations well into the future. I also want to take a moment to acknowledge and thank our Board of Directors for their confidence in me to lead our brand, and I am truly humbled by this opportunity. I look forward to the future of Wingstop with excitement and ask you all to join me in wishing Charlie the best in his new venture. Thank you for your time today.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Catalyst

-View CEO departure as a key catalyst.

-Removal of consumer stimulus, student loan moratorium and inflation eroding consumer purchasing power at low end of demos. 

-Earnings.

-Commodity.