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Roger Lipton’s Write -Up on WINGSTOP (WING)

April 14th, 2017 · No Comments

Wingstop is the most rapidly growing franchisor, among the publicly traded companies, and their same store sales growth has been without peer over the last four years. They are unique in terms of their “small box” and the attractive unit level economics (driven by 75% takeout, a very limited menu, and the price/value perception). Wingstop stores are heavily concentrated in California and Texas, so there is no doubt franchise opportunity elsewhere. Of course, the concept is not as well proven away from California and Texas, so potential franchisees should expect that new markets will take time to develop.

WINGSTOP

Foreword for FranchiseMoneyMaker readers from Roger Lipton
WWW.ROGERLIPTON.COM

WING: Company Overview (2016 10-K) (Jan’17 Investor Slides)
Wingstop is a Dallas, Texas based operator and franchisor of a global chain of restaurants specializing in fresh, boldly-flavored, cooked-to-order chicken wings, fries and sides. At the end of 2016, its 998 store system (21 US company, 901 US franchised, 76 International franchised) generated sales of $973.3M in the year. With its primary (“center of plate’) focus on wings flavored with 11 sauce options and the mantra “Wings, fries, sides, repeat,” it aims to distinguish itself from competitors also offering wings, but as an add-on item or a complement to a bar or to sports entertainment. The sauce options (fresh, hand-applied and tossed, range from mild to hot and spicy to savory to sweet, and have names such as Atomic, Mango Habanero, Cajun, Original Hot, Louisiana Rub, Mild, Hickory Smoked BBQ, Lemon Pepper, Garlic Parmesan, Hawaiian and Teriyaki) accommodate a wide latitude of tastes. Wings, fries and sides constitute 90% of sales. Fries are hand-cut and also freshly prepared, as are sides which include dips, coleslaw, bourbon baked beans, potato salad and freshly-baked yeast rolls. The company requires franchisees to purchase all restaurant operating products (chicken, equipment, signage, cleaning supplies etc.) in accordance with its specifications and from approved vendors. It negotiates regional or national contracts for chicken (~70% of all purchases) and other commodities. It has contracted with distributor Sygma Network, Inc. as a single source for purchase and delivery of all food and packaged items. The company receives vendor rebates based on system-wide volume purchases (~6% revenues).

The company has designed a simple, efficient and profitable restaurant operating model which has proven attractive to franchisees despite an increase in the royalty rate from 5% to 6% on new unit agreements since mid-2014. The domestic restaurants are a relatively small 1,700 sq.ft., due to their high (75%) take-out volume, and generate about $1.1M on average (or $655/sq.ft). The prototype’s operational simplicity is a factor in the low labor costs (about 22% for company stores averaging $1.7M per unit). The company discloses the cash outlay for a new leased unit at approximately $370,000 (excluding pre-opening expenses). It estimates new units generate $820K in year 1 and $890K in year 2, by which time cash-on-cash returns on new franchised units range from 35%-40% (or 31% to 36% including our pre-opening estimate of $46K), implying an EBITDA range of $130K-$148K, or EBITDA margins of 15%-17%. Subsequent revenue growth to the 2016 domestic store average of $1,113K would generate a cash-on-cash return of about 50%. An even more aspirational target is achieving the performance of company stores with their 2016 AUV’s of $1,729K & potential store-level EBITDA margins of about 17% (net of 6% royalty rate & vendor rebates). This has undoubtedly been the driver of the near doubling of store count (almost all franchised stores) in the past 5 years, and the impressive domestic pipeline of 518 new franchised unit commitments (79% from existing franchisees). There is an additional backlog of 349 international locations. The company believes it can grow to 2,500 domestic units, about half from building out existing markets and half from new markets.

As a public company only since June 2015, WING’s financial record is fairly limited, but what is available is strong. In the 5 years 2012-2016 comps averaged 9.5% propelling domestic annual AUV growth of 5.4%, which, coupled with annual unit growth of 16.3%, has driven domestic system-wide sales at a 20.8% annual rate. In that period WING’s own revenues (royalties & fees and company store sales) grew 15.4% annually, driving operating profits at a 26.2% annual pace and margin expansion by nearly 1,000bps to 32.0%. As an asset-light, highly franchised enterprise, ROIC in 2016 was 22.7%. Meanwhile, WING’s cash flows from operations have more than doubled in 2012-2016 from $10.4M in 2012 to $22.2M, while cap ex is up only about 25%. As a result, free cash flow has grown from $8.8M (17.18% of revenues) to $20.1M (22.0% of revenues). WING’s ratios of Debt to EBITDA and lease adjusted Debt to EBITDAR at 4.4X and 4.7X, respectively, is in line with highly franchised peers (>90% franchised).
The company plans to sustain its strong comp performance largely through expanding and refining its advertising strategy and enhancing its digital tools to manage operations and to mine data in support of its advertising initiatives. In early 2016 the franchisees voted to allocate 75% of its advertising spend to a national platform (vs. its previous 25% national, 75% regional allocation). The program aims to leverage scale to more efficiently purchase media and to achieve broader reach for its brand awareness initiatives, particularly in smaller and newer markets. It is also aiming to expand brand awareness using social media to communicate with its key customers: 18-24 male millennials and 24-34 millennial parents (particularly moms). In 2016 the TV campaign was waged in 10 domestic markets covering 60% of system sales and in 2017 the campaign will expand to 22 weeks in all domestic markets.

These brand awareness initiatives are supported by WING’s technology initiatives. With its 75% take-out rate, WING sees significant potential in enhancing on-line ordering through its digital platform. In 16Q4 19.7% of sales were made online, up from 17.7% the preceding quarter and 14.9% a year earlier. The company only has to look at Domino’s Pizza to see the potential. DPZ, also 98% franchised and also mostly take-out (or delivery in DPZ’s case), processes over 50% of its orders online and is rapidly expanding the range of devices on which it can process them. This facility has proven an important ticket builder, especially since on-line orders generate higher tickets, an incremental $4 in WING’s case ($20 vs $16). Also, a new POS system integrated with its digital platform will direct on-line orders straight to the kitchen. This would eliminate a step in the order process, reducing both the expense and order inaccuracies of the phone reps currently handling some 60% of total orders. It recently launched voice-activated ordering with menu item customization with Amazon Alexa technology (An illustrative order: “Alexa, ask Wingstop to order an 8 piece classic wing combo with lemon pepper, fries and ranch.”). At the end of 2016 the new POS system has been installed in 90% of domestic units.

WING: Current Developments (16Q4 ConfCall)
The Company wrapped up 2016 with 49 locations opened in Q4, bringing the year’s total to 153 net new restaurants across 30 different states and five international markets. At yearend 76 units were international , in five countries including Mexico, Singapore, the Phillipines, Indonesia and the United Arab Emirates. The rate of unit growth in 2016 obviously exceeded the company’s guidance of 13%-15% growth in 2017, but the possibility obviously exists that guidance will be exceeded.
Same store sales in Q4 were below previous expectations, at 1%, which the Company indicated might have reflected consumer uncertainty immediately following the election as well as late receipt of tax refunds. This slowing trend continued into the 1Q’17, domestic same store sales running down 2.6% year to date as of the conference call on 3/2. Management indicated, however, that sales had firmed late in February, possibly in response to National TV that started in early February, and turned positive in the two weeks prior to March 2nd. Management indicated that markets without dense concentration (and brand awareness) seemed to respond better than more well established areas. It should also be note that, while same store sales comparisons have steadily slowed over the last year or so, and company guidance is for low single digit growth, this is on top of five year (since 2012) comp growth of 47.3%.

Since there are only 19 company operated locations, and no additional units are currently in the pipeline, corporate growth is dependent on franchise unit growth and the sales of the franchise system. Commodity costs (chicken wings primarily) are obviously a system wide issue and are running higher YTY in Q1 by about 10%, but are expected to moderate for the year as a whole. Labor costs are a concern, industry wide, but WING locations have below average labor costs than most restaurant industry competitors, so franchisees should not be overly burdened. Rents, which are going up industry wide, are less of a concern here since locations (with access to lower to middle income consumers) are not usually in the same trade areas (for lower to middle income consumers) where most of their competitors want to be.

Management guided to EBITDA growth in 2017 of 13-15%, essentially matching projected unit growth. SG&A expenses are projected at $34-$35 million, versus an “adjusted for transactions costs” of $32.3 in 2016. Net Income after taxes is expected to be $18.5-18.8M, versus “adjusted” $16,9M, on 29.3 fully diluted shares (29.0M in 2016). Interest charges are expected to be up 27% as a result of the 2016 recap. The tax rate is assumed to be 37-38%, possibly a bit higher than the 37.2% in 2016, but GAAP presentation requirements can affect that, and a lower federal tax rate could obviously help materially.

Aside from the obvious challenge of successfully developing 130-150 locations (or more), and supporting 1,000 plus locations, the company continues to develop its on-line ordering platform, obviously a major competitive asset. WING has been the first restaurant chain, beginning to offer in January, voice activated ordering, using Amazon’s Echo platform. Importantly, the new national advertising campaign provides the possibility of regaining the substantial comp growth of a couple of years ago. There will not be additional marketing expense for franchisees, but the funds previously spent in local markets will be re-allocated to the national TV program. Last year, just over half of the US restaurants were supported by various levels of TV. 2017 will provide 100% coverage of the domestic store base, with TV provided for at least 22 weeks. Wingstop, as the most successful, and rapidly growing, participant in this sector, should maintain and increase its long term marketing advantage, since their advertising budget will naturally grow with the system.

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About the Author:
Roger Lipton is an investment professional with over 4 decades of experience specializing in chain restaurants and retailers, as well as macro-economic and monetary developments. After earning a BSME from R.P.I. and an MBA from Harvard, he began following the restaurant industry as well as the gold mining industry. While he originally followed companies such as Church’s Fried Chicken, Morrison’s Cafeterias and others, over the years he invested in companies such as Panera Bread and shorted companies such as Boston Chicken.
For more information please contact: WWW.ROGERLIPTON.COM OR
WWW.LIPTONFINANCIALSERVICES.COM

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