BWLD Report PDF

INVESTMENT MANAGEMENT CERTIFICATE PROGRAM May 1, 2015

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Consumer Discretionary -Restaurants

Buffalo Wild Wings

7/12 10/12 1/13 4/13 7/13 10/13 1/14 4/14 7/14 10/14 1/15 4/15$60

$80

$100

$120

$140

$160

$180

$200

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Source: FactSet Prices

Key Drivers:

Wholesale price of chickens: The price of chicken is extremely volatile. For a company that is dependent on wing sales, even a small price increase will have a huge impact on cost of goods sold.

Labor costs: New legislation all over the country is raising the minimum wage. As a result, company’s labor costs are rising. In an industry where margins are already tight, this severely eats away at the profits.

Growth: BWLD is hoping to open 700 more stores in the US and 1,300 stores internationally. With just over 1,000 stores open now, the company is planning on a future of growth.

Investing in other concepts: To mitigate the risk of the company, BWLD is looking to invest in 3-5 other concepts. Currently, the company has invested in two, one of which BWLD has a majority interest.

Valuation: Using a trading history valuation approach, Buffalo Wild Wings appears to be expensive. However, when comparing P/E to EPS growth, the company appears to be undervalued. DCF analysis, a third valuation technique, confirmed that the company is undervalued. The DCF analysis determined the intrinsic value to be about $200, while the shares currently trade at $175. Risks: Lack of growth, increase in wholesale price of chicken wings, decrease in pricing power, competitive marketplace, strike in professional sports, loss of licenses and permits, and general economic downturn.

Recommendation BUY

Target (today’s value) $200

Current Price $175.25

52 week range $122.15 – 195.83

All numbers as of 04/23/2015

Share Data

Ticker: BWLD

Market Cap. (Million): $3,453

Inside Ownership 1.6%

Inst. Ownership 94.2%

Beta 0.85

Dividend Yield 0.0%

Payout Ratio 0.0%

Cons. Long-Term Growth Rate 20.0%

‘12 ‘13 ‘14 ‘15E ‘16E Sales (Millions)

Year $1,040 $1,266 $1,516 $1,824 $2,230

Gr % 32.6% 21.7% 19.7 % 20.3% 22.3%

Cons - - - $1,801 $2,082

EPS

Year $3.08 $3.81 $4.98 $6.18 $7.36

Gr % 13.6% 24.9% 31.5% 24.6% 19.4%

Cons - - - $5.99 $7.20

Ratio ‘12 ‘13 ‘14 ‘15E ‘16E ROE (%) 16.3% 16.9% 18.1% 18.4% 18%

Rel Industry 0.49 0.51 0.55 0.74 0.68

NPM (%) 7.9% 5.6% 6.2% 9.3% 9.0%

Rel Industry 0.41 0.40 0.46 0.55 0.52

A. T/O 1.92 1.95 1.94 1.93 1.95

ROA (%) 10.5 % 11% 12.1% 12.4% 12%

Rel Industry 0.74 0.79 0.93 0.85 0.81

A/E 1.55 1.53 1.50 1.48 1.48

Valuation ‘13 ‘14 ‘15E ‘16E P/E 39.4 33.0 29.2 24.5

Rel Industry 1.82 1.59 1.35 1.36

P/S 2.2 2.3 1.7 1.4

P/B 6.0 6.0 4.4 3.7

P/CF 15.5 16.9 14.1 11.8

EV/EBITDA 14.6 14.2 10.3 8.4

Performance Stock Industry 1 Month (3.3%) 2.0%

3 Month (1.7%) 6.0%

YTD (2.8%) 8.0%

52-week 19.9% 10.5%

3-year 90% 19%

Contact: Cameron Karlen Email: [email protected] Phone: 920-422-0951

Analyst: Cameron Karlen

Summary: I recommend a buy rating with a target of $200. Buffalo Wild Wings has a large untapped international market that the company first broke into in 2014. This growth, coupled with steady domestic growth, will drive EPS over the next 10+ years. The stock is currently undervalued, based on a P/E to EPS growth comparison and a DCF analysis.


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Company Overview Buffalo Wild Wings, Inc. (BWLD) owns, operates, and franchises restaurants primarily in the United States and Canada. The company’s restaurants feature a variety of menu items, including its Buffalo, New York-style chicken wings spun in one of its signature sauces. BWLD focuses not only on serving delicious food and drinks, but also on creating an unforgettable experience for its guests. From the very beginning, the company’s focus has been on giving its guests an experience similar to that of actually attending the game.

Buffalo Wild Wings was founded by Jim Disbrow and Scott Lowery in 1982 at a location near The Ohio State University. Fast forward nearly 20 years, and this company turned from a local sports bar into a national chain. In 2003, BWLD issued an IPO raising $50 million to fund its growth. Since 2003, Buffalo Wild Wings has focused on growing its concept nationally. In 2013, BWLD reached its 10-year goal of opening 1,000 stores across the United States and Canada. Now, the company is looking to expand its product internationally.

Buffalo Wild Wings’ revenues are comprised of two extremely important parts: restaurant sales from company owned stores and franchise royalties and fees from its franchised stores. BWLD has seen its revenues increase significantly since 2008. In fact, if you look at figure 1, you will see that the company has experienced a 23.4% compound annual growth rate (CAGR) over the past seven years.

Buffalo Wild Wings, which struggled greatly in its early years, has evolved into a state-of-the-art sports viewing and technology platform, providing sports fans with the ultimate game day experience. By constantly putting the customer first, BWLD has set itself apart from local sports bars, making it the popular hangout place during the big game.

Buffalo Wild Wings: Wings. Beer. Sports.

Figures 1 and 2: Revenue Sources of Buffalo Wild Wings and Sales Growth

All numbers are in thousands Source: Company reports

Source: Company reports


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Business Drivers Though several factors may contribute to Buffalo Wild Wings’ future success, the following are the most important business drivers:

Wholesale price of chicken

Labor costs

Same-store sales

Domestic and international growth

Emerging brands

Economy

Wholesale Price of Chicken

Perhaps the largest driver affecting the restaurant industry is the wholesale price of food. Rising costs can erode profit margins if the company cannot pass the added expense on to the customer in the form of a price increase. More specifically, Buffalo Wild Wings’ driver is the wholesale price of chicken. In an attempt to counteract the volatility of chicken wing prices, Buffalo Wild Wings has introduced new menu items, effective marketing promotions, focused efforts on food costs and waste, and menu price increases. In addition, Buffalo Wild Wings began selling wings by portion in 2013, providing guests with a more consistent amount of chicken in their orders and decreasing the amount of yield fluctuations on cost of sales. Figure 3 (below) illustrates the fluctuating price per pound of chicken wings dating back to Q1 of 2009. Chicken wings accounted for 25%, 27%, and 19% of sales in 2013, 2012, and 2011, respectively, with an annual price per pound of $1.76, $1.97, $1.21, respectively. To illustrate the effect of this driver, consider a 10% increase in chicken wing costs for 2013. This would have raised the price per pound to $1.94, increasing the total cost of sales by approximately $9.1M. This would have been a 2.5% increase to the company’s total cost of sales. In January of 2015, the average price per pound of chicken wings was $1.90 per pound, which is a 40% increase over the $1.36 average in 2014. All else equal, this would have driven up the cost of goods sold, as seen in the previous example. However, as a result of the policy implemented in 2013 where the company began selling by weight instead of quantity, management was able to mitigate some, but not all, of the additional costs.

Chicken wings accounted for 25% of sales in 2013.


Figure 3: Wholesale Price per Pound – Chicken Wings


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So why does the price of chicken fluctuate so much? One of the main reasons is that the cost to raise chickens changes with the market. For example, the price per barrel of oil has fallen drastically since July of 2014. Extended lower fuel prices could eat the margin between gasoline and ethanol, making the latter less cost-competitive and ultimately holding the potential to cut demand, thereby lowering corn prices. Lowered corn prices means less money that farmers need to spend on feed for their chickens. This would ultimately result in lower wholesale chicken prices. However, this has not been the case since oil started its decline in mid-July. Instead, farmers have been taking advantage of the plunging price of corn and soybeans and giving their chickens extra feed. According to an article on Bloomberg, “The Super Bowl Wings Will be Fat, Yes, but Pricey Too,” the extra feed being given to chickens has helped to lift poultry production, as measured by weight, to a record. However, regardless of their weight, the actual number of chickens slaughtered fell last year, causing a drop of about 50 million wings. As a result, the wholesale price of chicken wings increased, causing Buffalo Wild Wings to raise menu prices by an average of 3% in November of 2014.

Labor Costs

In addition to the wholesale price of food, labor costs play a major role in the profitability of a company. This is especially true for companies in the restaurant industry, which already have very tight margins. For the year ended December 28, 2014, labor costs made up 31.2% of Buffalo Wild Wings’ total revenue. While the federal minimum wage is set at $7.25, actual minimum wages range from $5.15 in Wyoming and Georgia to $9.50 in Washington DC. Lately, there has been talk of raising the federal minimum wage to $15/hour. Unfortunately, there are no figures available that say the number of BWLD employees that this wage increase would affect. However, considering that most of the company’s employees are servers, they will need to make $15 an hour as well (hourly wage plus tips equaling to at least 15 an hour). Because of this, even a small increase to the hourly wage will drive up labor costs, slashing the margins even further. As seen in figure 4, net margins for the company are slightly above 5%. An increase in cost of labor could significantly decrease margins or increase prices.

Same-Store Sales

A third driver of Buffalo Wild Wings, and the restaurant industry as a whole, is same-store sales. Same-store sales are a measure of growth in existing stores. Stores often take several months, if not years, to reach the maturity necessary to make meaningful comparisons. If you look at figure 5, you will notice that the company increased its same store sales for company-owned restaurants from 4.85% in 2013 up to 7.23% in 2014. This shows that the company’s sales growth is not just a result of

2014 labor costs made up 31.2% of Buffalo Wild Wings’ total revenue.

Figure 4: Margins



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opening more stores. While this certainly plays a part, sales of existing stores are also rising, which is a great sign for the company going forward. The increase in same-store sales could be a result of two occurrences. First, the company has formed partnerships with various companies across the United States, most notably the NCAA, which has surely caused an increase in the number of customers. In addition, as mentioned earlier, Buffalo Wild Wings upped its prices at the end of 2014 by an average of 3%.

Growth Strategy

Buffalo Wild Wings’ vision statement is, “We will be a growth enterprise of restaurant brands, with more than 3,000 restaurants creating the ultimate guest experience worldwide.” Management’s plan to accomplish this vision statement is broken into three categories: Creating the ultimate guest experience in the United States and Canada, growing Buffalo Wild Wings into a globally-connected brand by expanding internationally, and by building an enduring, diversified portfolio of brands.

When Buffalo Wild Wings went public in 2003, it had 245 total stores; of these 245 stores, 161 were franchised and the remaining 84 were company owned. The company’s 10 year goal was to reach 1,000 total stores between the US and Canada. After 10 years and two months, the firm achieved this goal. Since 2001, BWLD has experienced a 14.7% compound annual growth rate (CAGR). Since 2008, the company has experienced a 10% CAGR. Figure 7 shows the company’s store expansion since 2001. Buffalo Wild Wings’ long-term goal is to open a total of 3,000 stores worldwide. Management believes that the company can successfully operate 1,700 stores in the United States and Canada, and a remaining 1,300 internationally. Currently, BWLD has five international restaurants, all located in Mexico. The company expects to open its first restaurants in the Philippines, United Arab Emirates, and Saudi Arabia in the first half of 2015. In addition, the company has five signed franchise development agreements for restaurants in the Middle East, Mexico, and the Philippines. The company is also pursuing franchise partnerships in India, South Korea, Vietnam, and throughout Latin America. In the next seven to 10 years, BWLD is expecting to have 400 international Buffalo Wild Wings restaurants.

BWLD has experienced a 10% CAGR since 2008.

Figure 5: Same-store sales by quarter from 2010-2014 for company-owned stores


Figure 6: Same-store sales by quarter from 2010-2014 for franchised stores



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A major concern surrounding Buffalo Wild Wings expanding into international territory is that locals will not respond to the brand as Americans do. For example, a burger company would have a very difficult time being successful in some areas of the world (i.e. India). However, chicken is a widely accepted protein around the globe. With that being said, BWLD will adapt its menu to meet the local culture. For example, even though alcohol sales made up 21% of sales in 2014 for company-owned restaurants in the U.S., BWLD won’t be able to serve alcohol in the Middle East. Management addressed this issue by saying, “…Our customer research shows that alcohol-free Buffalo Wild Wings has very high brand appeal in Saudi Arabia and the Middle East. Guests there still want to get together to watch their favorite sporting events or just to socialize. However, instead of gathering with friends to grab a beer, they drink fruit juice-based drinks.” This brings up another problem in that the entire Buffalo Wild Wings’ brand is based around the idea of gathering together to watch sports. Surely Saudi Arabians don’t care about Major League Baseball or the NFL. However, international soccer is much larger than the MLB and the NFL combined. There were 820 matches played during the 2014 FIFA World Cup in Brazil. The previous World Cup in South Africa attracted 2.2 billion viewers, compared to the 114.4 million who watched the 2015 Super Bowl. In addition to soccer, cricket is a very popular sport around the world. A restaurant designed for people to watch sports shouldn’t pose a problem outside of the United States.

Unfortunately for the investor, BWLD does not currently break out its international stores from its domestic stores. Since the company’s entire growth strategy is dependent on it’s international efforts, it would be helpful to know whether or not the current international stores are performing as well as its domestic counterparts. If this is the case, this reduces much of the company’s risk.

Emerging Brands

The third part of BWLD’s growth strategy is to build an enduring, diversified portfolio of emerging brands. Management is hoping to invest in 3-5 concepts to expand its portfolio. In May of 2013, Buffalo Wild Wings took a minority interest Pie Squared Holdings, operator and franchisor of a California-based fast-casual pizza restaurant, PizzaRev. PizzaRev has eight locations in California. As of April 2nd, 2014, PizzaRev has six franchise partners to help its growth plans. Currently, Buffalo Wild Wings owns two PizzaRev locations.

In addition to BWLD’s minority investments, the company has also made one majority investment in Texas-based company Rusty Taco, Inc. Rusty Taco is a fast-casual street-style taco restaurant chain headquartered in Dallas, Texas. Currently, Rusty Taco has nine locations located in Dallas, Denver,

Figure 7: Store growth from 2001 to 2014



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and Minneapolis/St. Paul. Two Rusty Tacos are company-owned, while the other seven are franchised.

Economy

A sixth driver for Buffalo Wild Wings, the restaurant industry, and growing businesses in general, is the economy as a whole. While all of the other drivers mentioned in this report are important, business success ultimately comes down to whether or not consumers spend their money in your industry and in your stores. According to the Bureau of Labor Statistics, total consumer expenditures on food away from home decreased by two percent from 2012-2013. However, total consumer expenditures on food away from home still made up 5 percent of all consumer expenditures and 39.8% of total food expenditures in 2013. It is important to compare these numbers with the consumer confidence index. If you look at figure 8, you will see BWLD compared to consumer confidence. The consumer confidence index measures how consumers feel about the upcoming six months and their plans to make purchases or not.

As you can tell, BWLD is extremely correlated to consumer confidence, with an annual correlation factor of 0.411 in figure 8. As consumer confidence improves, Buffalo Wild Wings and its peers perform extremely well. Figure 9 also shows that BWLD and its peers outperform the S&P 500 as confidence rises

After determining that BWLD and its peers are driven by consumer confidence, it is important to determine what exactly drives consumer confidence. As seen in figure 10, one of the main drivers of consumer confidence is unemployment. Unemployment is negatively correlated to consumer confidence, with a correlation factor of -0.385, meaning that as unemployment goes up, consumer confidence declines.

Total consumer expenditures on food away from home decreased by 2% from 2012-2013.

Source: Bloomberg

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Figure 8 and 9: Consumer Confidence Yearly % Changes Buffalo Wild Wings and competitors (BWLD Comp) Yearly % Changes (left) and Relative Price of BWLD Comp to S&P 500 versus Consumer Confidence (right)

Source: Bloomberg


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As a final comparison, I compared the money spent away from home on food to consumer confidence. As you can tell in figure 11, there is a very strong correlation between the two, with a correlation factor of 0.624 on an annual basis.

In conclusion, consumer confidence and unemployment, which is a key driver of consumer confidence, is negatively correlated. Money spent on food away from home and consumer confidence, which is a key driver of money spent on food away from home, is positively correlated. Finally, Buffalo Wild Wings and its peers are positively correlated to consumer confidence, a key driver of stock prices in the restaurant industry. Therefore, when unemployment decreases, I would expect to see Buffalo Wild Wings and its peer’s absolute and relative performance subsequently increase.

Financial Analysis

In 2015, BWLD will celebrate its thirteenth year as a publically held company. In that time, the company has established itself in the U.S. market, grown its brand name domestically, both through advertisements and partnerships, and the company has even started branding itself internationally.

Buffalo Wild Wings is expecting sales and profits to rise.

Figure 11: Relative Price of Money Spent on Food Away from Home to S&P 500 versus Consumer Confidence

Source: Bloomberg

Figure 10: Absolute Price of Unemployment Index (USURTOT) Versus Consumer Confidence Yearly % Changes

Source: Bloomberg


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With all of this in mind, Buffalo Wild Wings is clearly in the growth stage of the company’s life cycle. In this stage, it is expected that the company will have rising revenues, but not without rising costs. Throughout this section, we will explore how this growth has impacted the financials of the company since 2010. In addition, the financials of 2015 and 2016 will be forecasted.

Quantifying Chicken Wings

As mentioned in the driver section of this report, the wholesale price of chicken wings plays a huge role in the profitability of this company. By selling wings by weight instead of quantity, Buffalo Wild Wings has formed a layer of protection against the volatile price of wings. The average price of wings in 2012, 2013, and 2014 was 1.97, 1.76, and 1.55, respectively. If you refer back to figure 3, you will see that throughout 2014, the price of wings was trending upwards. If the price of wings continues to rise throughout 2015, it will surely impact company’s direct cost of sales. However, take note of the price increase every year in the fourh quarter. I would expect to see the price come back down in the first and second quarter of 2015.

As you can see in figure 12, direct costs have been rising. A more important consideration, however, is the direct cost as a percentage of sales, as seen in figure 13.

In the case of Buffalo Wild Wings, given the volatile nature of its drivers, direct costs as a percentage of sales will most likely change year to year. As mentioned earlier, the rising cost of chicken wings in 2014 is a result of farmers taking advantage of the falling price of oil and giving their chickens more feed. For a restaurant that serves its wings by quantity, this will significantly raise the direct cost of sales because, no matter the weight of the chicken, it still only has two wings. However, for a company that serves its wings by weight, like Buffalo Wild Wings, the direct costs should remain unchanged or even fall slightly because the company doesn’t need to buy as many chickens. As you can see, direct costs as a percent of sales fell in 2014. Serving wings by weight allows the company to take advantage of the falling oil prices along with the farmers.

In BWLD’s company reports, direct cost of sales are listed differently than they are listed in this report. Instead of grouping the restaurant operating costs into a single direct cost category, the company separates it into several categories, as seen in figure 14.

Figure 14: Restaurant Operating Costs

Source: Company Reports


Figure 13: Direct Costs Percent of Sales

Figure 12: Buffalo Wild Wings Gross Margin



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While Buffalo Wild Wings never explicitly says what expenses are used to form the cost of sales category, the majority of this is certainly food costs. With this in mind, I took the cost of sales category, as shown in figure 14, as a percent of sales over the past three years. For 2012, 2013, and 2014, the cost of sales as a percent of sales was 31.5%, 30.69%, and 29.09%, respectively. I then compared these percentages with the average wholesale price of chicken wings over the same time and derived a correlation coefficient of 0.655.

I then took the costs as a percent of sales as shown in figure 13 and compared it to the average wholesale price of chicken wings over the same three-year period. The result was a correlation coefficient of 0.141. As expected, this is significantly lower than the 0.655, which was calculated in the first example. However, when calculating the 0.141 correlation coefficient, all of the categories shown in figure 14 were used to calculate direct costs. In my opinion, including some of these items, especially the noncash items of depreciation and amortization, dilute the overall effect of chicken wings on the direct costs of the company. I believe that the actual effect of chicken wings on the company’s direct costs is between the two correlation coefficients.

In conclusion, the wholesale price of chicken wings is a significant driver for Buffalo Wild Wings. As demonstrated above, when the cost of wholesale chicken wings is rising, the restaurant operating costs are also rising. However, considering the fact that Buffalo Wild Wings is so popular, the company has significant pricing power. I would expect that in the case of rising costs, Buffalo Wild Wings would be able to pass most of this cost onto the consumer without decreasing the demand of its product.

Revenues

Since going public in 2003, Buffalo Wild Wings has experienced steady growth year after year. Between 2003 and 2014, Buffalo Wild Wings has had a compound annual growth rate of 23.0%. As seen in figures 15 and 16, I am expecting revenues to continue to grow in 2015 (20.3%) and 2016 (22.3%), which will give the company a 22.75% CAGR for the 14-year period.

As discussed in the driver section of this report, BWLD is not only looking to grow its operations domestically, but also internationally.

The wholesale price of chicken has a correlation coefficient of 0.141 when compared to the company’s total direct costs category.

Figure 15: Revenues since 2003



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Buffalo Wild Wings has averaged about 35 new company owned stores and about 39 new franchised stores each year. Whereas the number of new franchised stores has been relatively stable since 2003, the number of company owned stores has increased dramatically over the years, especially in the past four years. In the past four years alone, Buffalo Wild Wings has opened 232 company owned stores, or an average of 58 per year. Management expects to open 50 company owned and 50 franchised Buffalo Wild Wings in 2015, as well as 5 company owned and 7 franchised emerging brand stores. As discussed in the driver section, Buffalo Wild Wings vision statement was updated in 2013 to read, “We will be a growth enterprise of restaurant brands, with more than 3,000 restaurants, creating the ultimate guest experience worldwide.” Management is looking to continue the company’s expansion here in the United States, as well as expanding globally. For this reason, sales (company sales and franchise fees) are forecasted to grow in 2015 by 20.3%. Sally J. Smith, the CEO of Buffalo Wild Wings, is estimating that the company will grow by 18% in 2015.

Earnings Per Share (EPS)

In my analysis, I have determined that not only will revenues rise over the next two years, but also profits. In addition, EPS will subsequently increase. Figure 17 shows my estimate for Buffalo Wild Wings’ 2015 and 2016 EPS estimates. I expect EPS to rise in 2015 and 2016 to $6.18 per share and $7.36 per share, respectively. This is a fairly aggressive estimate, but it is doable if the company’s international efforts are a success.

As seen in figure 18, there are several drivers of the company’s EPS. By far the largest driver is sales growth from company-owned stores. Through increasing same-store sales and number of new stores, this driver is expected to add $1.11 to BWLD’s 2015 EPS. I also assume a modest rise in gross margin, which will add $0.21. Higher SG&A as a percent of sales will subtract $0.14. This higher

Figure 16: Revenue CAGR



Figure 17: Net Income and Earnings Per Share (EPS)

I am forecasting sales to grow in 2015 by 20.3%, which is slightly more aggressive than BWLD’s estimate of 18%.


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Figure 18: Quantification of 2015E EPS Drivers

SG&A is natural for a company that is growing its operations. However, SG&A won’t grow dollar for dollar with rising revenues because many of the items in this category aren’t affected by growing operations, such as the salary of the CEO.

Since forecasting financials is both an art and a science, it is important to compare one analyst’s estimates with the consensus of other analysts studying the same company. Factset has compiled estimates from 23 analysts. Figure 19 shows the consensus EPS.

As you can tell from comparing figure 17 and figure 19, my estimates are a bit more aggressive than the consensus estimates. I believe in my estimate because of the company’s history of strong growth, and the addition of stores internationally. My sales estimates are a bit higher than consensus, which explains my above consensus EPS forecasts. Figure 20 shows EPS of a six-year period for both Buffalo Wild Wings and the restaurant industry. Over this time, EPS for both BWLD and the restaurant industry have been growing quickly. Both are also expected to have continued, robust growth.

Figure 20: Comparison of EPS Growth by Quarter between BWLD and Comps

Source: Company Reports and FactSet

Figure 19: Consensus EPS

Source: FactSet


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Return on Equity (ROE) and Return on Assets (ROA)

As seen in figure 21, Buffalo Wild Wings’ return on equity has been trending upwards. This is a good sign for investors, showing that through the years, management has created more value for shareholders. Since this number can also rise by taking on increasing debt levels, it can often be somewhat misleading if taken by itself. However, BWLD has a low asset to equity ratio and no long-term debt. Thus, the firm has not “manufactured” a high ROE through financial leverage.

As you can tell from figure 21, ROE is rising in 2015 by 0.3%. This is being driven up by the 0.3% increase in the operating margin, and a corresponding 0.4% increase in ROA. It is important to compare these numbers with the industry averages. The restaurant industry has a five-year average ROE and ROA of 32.40 and 11.90, respectively. Buffalo Wild Wings had a slightly above average for ROA in 2014. Buffalo Wild Wings’ ROE is significantly lower than the industry average; however, this just means its leverage (and risk) is lower than the industry. BWLD has a 0% long-term debt to equity, while the industry’s median/average is 44.5%/161.5%, respectively. Figure 22 (below) shows a comparison between Buffalo Wild Wings’ and the industry’s ROA between 2005 and 2014. Figure 23 shows a comparison between Buffalo Wild Wings’ and the industry’s ROE for the same time.

Free Cash Flow

Free Cash Flow (FCF) is another way to measure the earning potential of a company. Since earnings can be altered using various accounting methods, many investors believe that free cash flow is a better indication of where the company is headed than earnings. FCF shows the company’s potential to pay dividends, reduce debt, buy back shares, make acquisitions, develop new products, etc. In the end, FCF is another indication of how well the company will be able to add value to shareholders.


Figure 21: 5 Stage Return on Equity

Figures 22 and 23: Comparison of BWLD’s ROA with the Industry, and a comparison of BWLD’s ROE with the industry

Source: Company Reports and FactSett

ROE is expected to increase in 2015 to 18.4%. This is most likely caused by increases to the operating margin and ROA.


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Since BWLD does not have any debt, there is no interest expense. Because of this, free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) are the same. One of the numbers used in calculating FCFF is the change in Net Operating Working Capital (NOWC). For a company that receives payment from customers upfront, like most retail stores and restaurants, NOWC is negative. The same is true for Buffalo Wild Wings. Figure 24 shows the operating assets, operating liabilities, and NOWC with and without cash for the company from 2010 to 2016.

In addition to changes in NOWC, FCFF also takes into account the company’s NOPAT and changes in Net Fixed Assets (NFA). Since BWLD is still in its growth stage, its FCFF has been extremely volatile. In 2015 and 2016, I am forecasting BWLD’s FCFF to rise to $25,219 and $38,143, respectively. However, when cash is included in the FCFF calculation, FCFF for 2015 and 2016 is -$9,875 and -$10,500, respectively. When including cash in the calculation, FCFF has not been positive in the sample taken (2011- 2016E). It is important to note that this negative number does not inherently show poor management and/or poor performance. While investors would much rather see this number be positive, the fact that it is negative just shows that the company is making large expenditures. Recall, BWLD has opened an average of 58 company owned stores each year since 2011. This is a large investment, which is the reason that FCFF is negative in this situation. As seen in figure 25, net fixed assets are the largest use of cash each year. I am expecting this number to grow in 2015 and 2016. In 2013 and 2014, BWLD’s change in NFA was less than net income. Because of this, net income was able to fund the company’s NFA growth. However, in 2011 and 2012, change in NFA was larger than net income, and other financing was needed. Figure 26 shows the other sources of financing. Notice the sale of marketable securities in 2011, 2012, and 2013. I am expecting cash to grow for the next two years, so BWLD will look to grow its marketable securities as well. If needed, selling off marketable securities in the future is always an alternative to financing operations instead of taking on debt.

Figure 24: BWLD operating assets, liabilities, and NOWC


Figure 26: Total financing provided


Figure 25: Total financing needed



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Finally, it is important to look at the impact that all of this has on BWLD’s cash account. The company’s cash account is growing. Since the company was able to fund its growth entirely with its net income in 2013, the company’s financing needs have significantly decreased. As a result, the company’s cash accounts have dramatically increased.

Valuation Analysis Buffalo Wild Wings was valued using multiples and a 3-stage discounting cash flow model. I believe that the best valuation technique for Buffalo Wild Wings is a P/E to EPS growth comparison. Few other techniques are able to capture the growth expectation, which is a significant driver in the company’s market price. DCF was also a good measure because I was able to include P/E. Based on most of the techniques used in this section, the company was found to be slightly undervalued. Trading History The first valuation technique that I will use is based on the average P/E ratio of the past five years. As seen in figure 28, the company’s average P/E LTM since April of 2010 has been 30.15. If this P/E holds over the next year, 2015’s target price can be calculated as follows:

2015 estimated P/E (30.15) * 2015 EPS (6.18) = Target price of $186.33 Assuming the average P/E remains the constant throughout 2015, the fair value for BWLD is $186.33. However, since this is the target price for the end of 2015, it is important to discount it back to today’s dollars. Using this method, today’s target price is $171.26. Since it is unlikely that the P/E will remain the same, it is important to only use this number as a starting point, and not the sole valuation technique.

Figure 28: P/E (LTM) Trading History, 04/2010 – 04/2014

Source: FactSet

Figure 27: Change in cash



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It is also important to consider BWLD’s P/E relative to its comparables. As seen in figure 29, Buffalo Wild Wings’ P/E has been higher than its comparables for the entire selected time period (since April 2005). This is expected because of the high growth rates. As seen in the comp sheet in appendix 5, BWLD has had a long-term earnings growth rate of 20.0% as compared to the median growth rate for its comps of 15.5%. Even if it is somewhat justified, this also means that the company is richly valued compared to its peers. Another important metric to consider in trading history valuation is net margin to sales. As you can tell from figure 30, net margins have been fairly stable, with a dip in P/Sales during the recession. In addition, take note of the correlation between the two. As net margin rises, so does P/Sales. This stability is something to consider when formulating a target price.

Buffalo Wild Wings has a LTG 4.5% higher than its comps’ average

Figure 29: Relative P/E LTM (04/2005 – 04/2014)

Source: Company Reports, IMCP Financial Model

Figure 30: Absolute Net Margin to P/Sales



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Comparative Valuation The next valuation technique that will be used is a comparison of P/E to LTG. In my opinion, this is the best way to value Buffalo Wild Wings because it is able to capture the long-term growth with market expectations in the target price. Using the same method that I used to calculate a target price for P/B to ROE, I was able to find a target price using P/E to the estimated 2016 EPS growth rate.

Estimated P/E = Estimated 2016 growth rate (19.1%) * 120.58 +13.401 = 36.43

Target Price = Estimated P/E (36.43) * EPS (7.36) = $268.12 Assuming the relationship holds going forward, the fair value for BWLD at the end of 2016 is $268.12, or $226.51 today. I think this is a more accurate valuation technique than P/B to ROE because it takes into account the company’s high growth rates. As mentioned previously, R-squared shows how much of a change in Y is explained by movements in X. In this case, about 89% of the changes in P/E are explained through EPS growth. In other words, investors are likely to pay more per dollar of earnings when EPS is growing. As a final comparison, I also created a composite ranking of several valuation and fundamental metrics. The analysis is shown in figures 34 and 35. I compared the estimated 2016 P/E to an equal weighted composite of NTM ROE, 2014 NPM, and NTM sales growth. This analysis shows that BWLD is undervalued, but so are the majority of its comps. This comparison shows that the company has a 24% appreciation potential, giving the company a target price of $217.31.

The composite ranking gives BWLD a 24% appreciation potential.

Figure 31: P/E EPS Growth



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Discounted Cash Flow Analysis (Details in Appendix 8) A three stage discounted cash flow model was also used to value Buffalo Wild Wings. For the purpose of this analysis, the company’s cost of equity was calculated to be 8.79% using the Capital Asset Pricing Model (CAPM). The underlying assumptions used in calculating this rate are as follows:

The risk free rate, as represented by the ten-year Treasury bond yield, is 1.96%.

A five year adjusted beta of 0.85 was utilized since the company has slightly more risk than the median risk of its comps, which was 0.7. However, I believe that the company is slightly less risky than the market.

A long-term market rate of return of 10% was assumed, since historically, the market has generated an annual return of about 10%.

Figure 32: Composite Relative Valuation

Figure 33: Composite Relative Valuation



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Given the above assumptions, the cost of equity is 9.79% (1.96 + 0.85 (10.0 – 1.96)). Stage One - The model’s first stage simply discounts fiscal years 2015 and 2016 free cash flow to equity (FCFE). Remember that since BWLD does not have any debt, FCFE and FCFF are the same number. These per share cash flows are forecasted to be $1.22 and $1.69, respectively. Discounting these cash flows, using the cost of equity calculated above, results in a value of $2.92 per share. Thus, stage one of this discounted cash flow analysis contributes $2.92 to value. Stage Two - Stage two of the model focuses on fiscal years 2017 to 2021. During this period, sales growth is assumed to normalize somewhat, starting at 18% in 2017 and falling by 2% each year. In addition, since BWLD is looking to grow the company, I have its NFA growing by 15% in 2017. This growth will decline slightly each year, resulting in an 8% growth in 2021. The resulting cash flows are then discounted using the company’s 8.79% cost of equity.

Stage Three – For the terminal value of the company, you may recall, fiscal year 2015 and 2016 earnings per share are forecasted to be $6.18 and $7.36, respectively. It was then assumed that earnings per share would grow, from these forecasted numbers, at a declining annual growth rate for the next five years (Figure 32). Stage three of the model also requires an assumption regarding the company’s terminal price-to-earnings ratio. For the purpose of this analysis, it is assumed that because of the large untapped international market, Buffalo Wild Wings’ price-to-earnings ratio will remain above the market because of the growth potential. Since investors are willing to pay for growth (as seen in the P/E to EPSG comparison in figure 33), a higher P/E is expected in growth situations. A price-to-earnings of 23 is assumed at the end of 2021. Note that this is much lower than today’s P/E. However, when forecasting out this many years, it is important to do so using a normalized P/E ratio. This also reflects the assumption that after 2021 the firm’s growth will continue to slow (2021 is only 10%, or ½ of the current rate). Given the assumed terminal earnings per share of $14.00 and a price to earnings ratio of 23, a terminal value of $322.00 per share is calculated. Using the 8.79% cost of equity, this number can be discounted to a present value of $178.49. Total Present Value – Given the above assumptions and utilizing a three stage discounted cash flow model, an intrinsic value of $199.77 per share is calculated ($2.92 + $18.36 + $178.49). Given Buffalo Wild Wings’ current price of $175.25, this model indicates that the stock is slightly undervalued. (See appendix 8, figures 37 and 38 for DCF Model) Sensitivity Analysis – Since Buffalo Wild Wings’ growth will last longer than seven years, it is difficult to find a normalized price-to-earnings ratio. In fact, if Buffalo Wild Wing’s growth is as high as it is

Figure 35: EPS Estimates for 2015-2021


BWLD is slightly undervalued with DCF analysis, with an intrinsic value of $199.77

Figure 34: FCFE and Discounted FCFE



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now, there is a chance that the price to earnings could even rise over the next seven years. If this happens, the market will be valuing the company much higher than I am. However, since constant growth is difficult to maintain the larger a company becomes, I have determined that over the next seven years, growth will slow and the P/E will fall. Through the various valuation techniques used in this report, I have determined that the target price for Buffalo Wild Wings is $200. However, a number of economic and company specific factors could alter this valuation. Company specific risks are discussed in the next section of this report.

Business Risks I believe that Buffalo Wild Wings is trading slightly below its intrinsic value; the following are risks to my bullish thesis:

Lack of growth, especially in the international market

Wholesale price of chicken wings experiencing significant price increases

Company’s pricing power decreased

Competitive marketplace

Strike in professional sports

Losing licenses and permits

General economic downturn

Lack of growth On several occasions throughout this report, I talked about Buffalo Wild Wings being a growth company. If BWLD fails to open new stores as planned, both domestically and internationally, its growth will suffer. My forecasts were calculated with the company’s growth in mind. In addition, the company’s 10-K discusses the importance of opening new stores on schedule. If the company consistently experiences delays, it could severely hurt the company’s ability to meet its growth objectives, and subsequently its forecasted financials. Chicken Wing Volatility While the company has taken great measures in combating the negative effects of rising chicken wing prices, it is not entirely immune to it. However, if the wholesale price of wings increases significantly, the company will have a difficult time passing it on to the consumer. This could severely affect the company, slashing profit margins and slowing growth. Company’s Pricing Power Decreased One of the greatest shields that BWLD has to protect itself from rising costs is its ability to pass the increase on to the consumer. However, the higher the company raises its prices, the less pricing power the company retains. It is important that the company’s pricing power remains intact to protect itself against major cost increases. Competitive marketplace Buffalo Wild Wings has a well-established brand, which goes a long way in keeping its ground in the marketplace. However, local sports bars and other casual dining restaurant always pose a threat to the business. Buffalo Wild Wings must focus on continually improving its offering and positioning itself to continually be successful in the marketplace.


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Strike in Professional Sports Since Buffalo Wild Wings is so dependent on sports, a huge risk factor for the company is that professional sports will not continue as we know them today. If there is a strike, lockout, or labor dispute in any of the major sports, Buffalo Wild Wings will experience major losses. According to the company’s 2014 annual report, sales have been higher during the fall and winter months based on the relative popularity and extent of national, regional, and local sporting and other events. If these sports seize to continue, sales will be severely impacted. Licenses and permits Since Buffalo Wild Wings is a company that provides food and alcohol, there are certain licenses and permits needed to continue doing business. According to the company’s annual report, “Local authorities may revoke, suspend, or deny renewal of our food and liquor licenses if they determine that our conduct violates applicable regulations.” Losing its alcohol license would severely hurt sales. However, failing a health inspection test could shut down the entire business. General Economic Conditions As with any business, poor economic conditions will slow sales and growth. This is especially true for companies found within the GICS consumer discretionary sector. For this reason, it is extremely important that Buffalo Wild Wings continues its growth internationally so that the risk is reduced through geographic diversification. It is also important that the company continues investing in other concepts to further mitigate the risk.


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Appendix 1: Sales Forecasts


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Appendix 2: Income Statement


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Appendix 3: Balance Sheet


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Appendix 4: Ratios


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Appendix 5: Comp Sheet


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Appendix 6: SWOT Analysis

Strengths: Weakness:

Strong brand recognition in America and Canada

Large, diverse menu, but with a specialty in chicken wings

Partnership with the NCAA

The Blazing Challenge is a great marketing technique

Guest loyalty strong, as seen in a strong same-store sales number

A somewhat restrictive concept; Turn off to non-sports fans

Expensive compared to local bars

There are no existing patents protecting the company’s products. Anyone can sell chicken wings.

Opportunities: Threats:

Untapped international market

Brand diversification

Creating a more “family friendly” menu

Make take out sales a bigger part of revenue stream

Delivery services

Competition is fierce, both with other casual dining chains and local sports bars

Dependent on sports. A strike in the NFL, for example, could really hurt business for six months of the year

Rising labor costs

America looking for healthier food options

The ever increasing time-poor society is looking for faster food options


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Appendix 7: Porter’s 5 Forces Threat of new entrants: Medium

No patents needed (-)

Heavy capital requirements (+) o Must establish a brand through marketing (expensive)

Customer loyalty to help establish brand (+) o Tough to gain that loyalty

Difficult to form brand equity, though necessary (+)

A study conducted by H.G. Parsa in Ohio determined that the failure rate for restaurants is about 61% in the first three years

At this point in time, tough to create product differentiation (+)

No switching costs for the consumer (-)

Low barrier of entry (-)

Difficult to compete against established brands (+)

Can choose a franchise or sole proprietorship, which makes it easier to enter the industry (-) Threat of substitute products or services: High

Since there are low barriers of entry, there are many options for the consumer (-) o Includes both casual dining restaurants and local sports bars o Can even include fast food and fine dining restaurants

Consumers can decide to cook at home instead (-) o A huge threat, especially in economic downturns

Low switching costs, if any at all

Product is not unique, so close substitutes elsewhere Buyer Power: Medium

Customers not overly sensitive to price increases (+) Switching costs low, if any at all (-) Food concept isn’t unique, so customers can just go somewhere else (-) High number of potential customers (+) Products are undifferentiated (-)

Supplier Power: Medium

Large number of firms (+) Low power over suppliers (-)

o Esp. chicken wing prices and cost of labor Intensity of competitive rivalry: High

No real sustainable competitive advantage (-) o Only brand name, but that isn’t usually sustainable in the long run

Competition with other casual dining, fast food, and fine dining restaurants (-) o Also competition with sports bars and delivery services


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Appendix 8: Three Stage DCF Analysis

Figure 37: Three-stage DCF Model Assumptions and Requirements


Figure 38: Three-stage DCF Model


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