A lot has happened with Buffalo Wild Wings (NASDAQ:BWLD) in 2017, but none of it has been that good for shareholders. An activist insider got heavily involved, there was a proxy war, the CEO is retiring after more than 20 years with the company and the business focus shifted dramatically.
The result? BWLD stock entered the year trading around $150. Now it sits just above $125. That is as low as the stock has been since October of 2014.
Clearly, investors are concerned about the future of the company. There has been a notable lack of clarity as to what actions the new management team will take to execute a turnaround, and investors don’t like it when they don’t have visibility. Consequently, analyst downgrades have rained down and investors have cashed out.
But BWLD stock is starting to look like a contrarian’s dream at these levels.
For those who can stomach some near-term turbulence, Buffalo Wild Wings could be a big, long-term winner.
What Is Going On At Buffalo Wild Wings?
For a while, BWLD was one of Wall Street’s favorite restaurant stocks. In fact, in every single year from 2003 to 2015, company-owned same-store sales growth was positive. That includes 2007 (+6.9%), 2008 (+5.9%), and 2009 (+3.1%), so even the recession couldn’t knock BWLD off its growth course. Revenues went from $126.5 million in 2003 to $1.8 billion in 2015. Operating margins grew from 5.6% in 2003 to 7.6% in 2015. Earnings per share rose from $0.65 to $4.97.
During this run, shareholders were greatly rewarded. In 2003, BWLD’s IPO price was $17. By the end of 2015, BWLD stock was trading around $160, a 9-times return in 12 years.
But 2016 marked a turn for the worse for Buffalo Wild Wings. The restaurant chain started to see comps go negative, and that was a sign of many things. One, the domestic market was nearing saturation. Two, competition in the “wings and things” space was heating up. Three, food delivery was starting to eat into market share, as more and more consumers opted to order in over dining out.
As the topline growth story began to stagnate, expenses continued to go up. Chicken prices rose, labor inflation continued and restaurant operating costs continued to grow with the store base.
That cut margins from 7.6% in 2015 to 6.9% in 2016. The slowing topline growth (+10% versus +20% the year prior) coupled with this margin compression led to pedestrian earnings-per-share growth of just 3% in 2016.
In steps activist investor Marcato Capital. In 2016, Marcato publicly ripped BWLD for keeping “the best opportunities for itself” and proposed that the company turn things around by focusing on franchising restaurants. For a long time, BWLD has operated with a 50-50 split between company-operated and franchised restaurants. Marcato believed that was wrong, and emphasized a franchise-heavy restaurant base to grow margins and open more locations at lower costs.
The battle between Marcato and BWLD has ultimately culminated in a Marcato victory. Marcato won some board seats and CEO Sally Smith is retiring. Those are some big changes in a short time frame.
Investors are now left wondering … what’s next?
Why the Sell-Off in BWLD Is a Buying Opportunity
For the most part, Marcato is right, and the changes the activist investor intends to implement should unlock significant value for shareholders.
The most recent earnings report is proof of this. The top-line story is fine, as same-store sales rose 0.5% versus expectations for a 0.1% gain. Yes, it’s slower than what the company posted from 2003 to 2015, but it’s only natural for things to slow after a period of prolonged growth. The +0.5% mark also outperformed both the negative restaurant industry and the negative casual dining segment.
Clearly, consumers continue to see value in Buffalo Wild Wings. As cord-cutting accelerates and at-home live sports entertainment becomes less prevalent, Buffalo Wild Wings will increasingly become the go-to place to watch sporting events. This tailwind should help traffic trends remain healthy into the foreseeable future, especially without much competition.
The problem at BWLD is with the margins. Increased promotional activity drove the cost of sales 170 basis points higher. Higher wages drove labor costs 80 basis points. Higher maintenance expenses drove restaurant operating costs 80 basis points higher. Across the board, costs are going up. Some of these costs, such as increased promotional activity, are necessary to drive sales. Other costs, though, such as labor costs and maintenance expenses, become a lot smaller in a franchise-focused business model.
In Q1, labor costs and restaurant operating costs together accounted for 46.8% of sales.
That is a big chunk to cut down on, and a franchise-focused business model will do just that.
So, in a nutshell, BWLD doesn’t really have a problem on the topline. They HAD one in 2016, but comps have once again turned positive in 2017, and will likely remain in the low positive territory into the foreseeable future. Buffalo Wild Wings just has an expense problem, and Marcato’s proposed changes will fix that expense problem.
The stock is acting like there is something wrong with the entire business. That just isn’t the case, and this irrational sell-off has created a compelling buying opportunity.
Bottom Line on BWLD Stock
The stock has lost a lot of value due to uncertainty about forthcoming changes, but such changes could unlock tremendous value for shareholders through substantially growing margins.
At multiyear lows, BWLD stock looks like a contrarian buy here.
As of this writing, Luke Lango was long BWLD.
