By Brian Nelson, CFA
It turns out that franchisees selling restaurants back to the franchisor is the red flag we knew it was. If you recall, Buffalo Wild Wings (BWLD) announced deal-related expenses related to the acquisition of more than 40 franchised locations in Texas, New Mexico, and Hawaii, “We’ll Be Looking to Add to B-Dubs Sometime after the Drop (October 2015),” and at the time, we were willing to give the restaurant the benefit of the doubt that this wasn’t the red flag it turned out to be. We were wrong. After all, if owning a B-Dubs is so hot, then why would the franchisee be looking to sell it back to the company, and why to the company? Wouldn’t another buyer perhaps be more interested in scooping up established locations? Something wasn’t quite right then…and something’s not quite right now either.
We were again disappointed by the restaurant that prides itself on providing “beer, wings, and sports.” Buffalo Wild Wings represents in part the growth engine of the Best Ideas Newsletter portfolio in the restaurant space, and frankly, we were surprised to witness same-store sales decrease 1.7% at company-owned restaurants and 2.4% at franchised restaurants during the first quarter ended March 27, 2016. Management is “dissatisfied to report a same-store sales decline” and is “undertaking several sales-driving initiatives to regain momentum.” We don’t think that wing lovers have all-of-a-sudden started to dislike the entree, but we think competition is proliferating from all over the food spectrum. Wingstop (WING) may be Buffalo Wild Wings’ closest public rival, but Domino’s (DPZ) has become a prime player in the market, “one of the most popular items on the Domino’s menu,” and Yum! Brands’ (YUM) Pizza Hut is not backing down with WingStreet.
We continue to believe in the “3 Reasons Why Buffalo Wild Wings Is a Long-Term Winner (July 2015)” but rivalries have certainly stepped up their game in today’s market, and it isn’t very encouraging to witness such weakness at B-Dubs during March Madness season, one of its strongest periods of the year, given its ties to college towns. It’s possible that Buffalo Wild Wings is dropping the ball on service, as CEO Sally Smith noted new initiatives around its FastBreak lunch program regarding speed-of-service guarantees. The company is also looking to capture some of the “value” market with Wing Tuesdays, which would offer different pricing and bundling options. The push to attract soccer fans to its restaurants has become a top priority this summer as the sport continues to grow in popularity in the United States. Remodeling efforts at some locations may reignite the spark in comparable sales, but the company will have to rigorously attack costs and overhead in light of threats of rising wing costs, which will squeeze margins and earnings.
We think it is important readers acknowledge how much Buffalo Wild Wings’ fundamentals have deteriorated from just 12-18 months ago. Not only has the company fallen short of expectations in 2015, but it reassured investors that 2016 would be solid, pointing to strong net earnings expansion. Concurrent with its first-quarter press release April 26, however, the company’s outlook for 2016 earnings per share guidance in the range of $5.65-$5.85 per share came in below the $6+ estimate we had been looking for. Not only this, but we now believe the investment cycle to get the company back on track may be longer than what we had been previously forecasting, and we think advertising costs to regain momentum against strengthening “wing” rivals will further pressure margins. We still like Buffalo Wild Wings over the long haul, but we’re growing more and more worried with each fundamental data point that crosses our desk. We were right to shed shares of B-Dubs September 2014, but we mistimed adding them back to the Best Ideas Newsletter portfolio, however, and we’re paying the price until shares recover. B-Dubs has become a long-term holding, and that’s okay.