WingSTOP before You Get Krispy Kreme’d

Wingstop (NASDAQ: WING) is at the same juncture as Dunkin’ Brands (NASDAQ: DNKN) and Krispy Kreme (KKD) were, 7 quarters out of their IPO gates.  The comparison is relevant in that all three companies virtually share the same business model.  Yet, they also faced different business environments at the time.

Common Business Model

In case you didn’t know, Wingstop sells chicken wings; Dunkin’ Brands and Krispy Kreme sell doughnuts.  Other than the fact that the majority of their revenue has been generated from a single consumer product, they are the only public firms selling that single product (Krispy Kreme went private in 2016).

Specialization: Wings, a side item, and a soft drink make up 92% of the orders that Wingstop fills. This heavy specialization in wings makes it easy for the company to communicate its products and menu makeup and keep costs low. It also allows the company to compete on the quality of their single product.  With its business concept being built around selling chicken wings in a fast casual, convenient setting, Wingstop has a competitive advantage over restaurants that have elaborate menus by perfecting only one product.

Move to a Franchise-Heavy Model: For Wingstop, royalty revenue and franchise fees were $57.1 million, an increase of $10.4 million, or 22.2% from 2015. Royalty revenue increased primarily due to an increase in the number of franchised restaurants.  On average, the revenue of a typical franchised restaurant is $1.1 million and it costs about $375,000 to build a new location because of its small size.  The profit margin for a franchised restaurant is over 34% which is twice of the overall margin.  As a result, there were 151 franchised stores vs. 2 company-owned stores opened in 2016, and 98% of Wingstop’s stores are franchised.  Similar to Dunkin Brands and Krispy Kreme, there is an industry trend moving towards a more profitable franchise-heavy model.

Long Thesis

Since its IPO in 2015, Wingstop has been able to benefit from the following new business environment which was not available to Dunkin’ Brands and Krispy Kreme at their IPOs.

Fast-Casual Trend: The fast-casual concept allows customers to sit down to have a formal dine-in experience that higher quality foods can be quickly prepared at a near fast-food cost. Wingstop provides the alternative for a quick, casual and quality meal at a lower cost.  The average meal cost per person is around $15.  Other than fast and casual, Wingstop is also comfortable for every group. Their business model is appropriate for people of all ages. Wingstop offers more family-oriented atmosphere than competitive chains like Buffalo Wild Wings (NASDAQ: BWLD), Wing House, or Hooters which serve alcohol in a bar or sports-centric setting.

Online Ordering: Since the implementation of Wingstop’s Point of Sale (POS) system in 2014, online ordering has increased from less than 7% to 15% of sale just in the second half of 2015. Over 2016, online orders contributed nearly 20% of the total sales.  Millennials, Wingstop’s target customer group, respond to online ordering the most.  Investments in technology will soon pay off as it attracts millennials.

Stay Home and Chill: The term “chill factor” refers to a trend we see people looking for convenience, saving time, and low cost.  The chill factor creates a new “stay home economy” of which Wingstop is a direct benefactor.  When people decide to stay home and chill with friends, they usually do not pick up burgers or donuts.  More than 75% of Wingstop’s revenue is from takeout orders.  Furthermore, Wingstop was the first restaurant to successfully launch dynamic social ordering on Facebook Messenger and Twitter.


Short Thesis

That being said, a good product is not necessarily a good company.  A good company is not necessarily a good stock.  It may be fruitful to compare three very similar companies and their stocks at the same point of their product life cycles.  As our interest is Wingstop, and it is at the point 7 quarters after is at 7 quarters after IPO.  Thus, the time 7 quarters after IPO becomes the common “event” for all three companies.  At this time, three companies have all experienced significantly different underlying fundamentals.  Krispy Kreme had the highest year-to-year revenue growth at 43.7% and earnings growth of 93%.  On the other side of the spectrum, Dunkin’ Brands had a 6.29% revenue growth and 8.93% earnings growth.  Wingstop is practically right in the middle.  It has over 20% revenue and earnings growth rates and an impressive 17% profit margin.   On the other hand, by the end of 2015, Wingstop had sold 530 total commitments domestically and 284 internationally to open new franchised restaurants.  By the end of 2016, Wingstop had a total of 998 stores which are 40% of their goal of 2500 restaurants.


Franchise Risk: A substantial portion of Wingstop’s revenue comes from royalties generated by franchised restaurants. Franchise royalties constitutes a substantial portion to support the future growth.  Accordingly, Wingstop is reliant on the performance of their franchisees in successfully operating their restaurants and paying royalties to the company on a timely basis.

Expansions into New Markets: Wingstop has been developing internationally while the company continues to open restaurants in new markets in the United States. In some of these markets there may be limited or no market recognition of Wingstop’s brand. Those markets may also have local competitive conditions such as differences in consumer tastes and culture.  Franchisees may find it more difficult in new markets to hire, motivate and keep qualified local employees who can project our vision, passion and culture. As a result, it may take longer time and cost more to start a new franchise store in international markets.

Wings Falling From Grace: While the fast casual industry can deliver quality food fast, the concept may also test new products fast.   However, there is always an inherent risk that fast casual industry will change with the times. These restaurants face high attrition rates in staff, managers, and diners. The restaurants are chock full of people looking for the next hot item, but as soon as something else comes along, the can be gone as fast as they came.  For the one-trick-pony Wingstop, the demand for speedy delivery and maintaining a good attitude may eventually create a toll on the workers. Additionally, the restaurant industry in general has a reputation for having one of the highest employee turnover rates of any industry. The combination of the lack of sales stability and a high strain on the work force can create a less than desired business situation for the company.

Over-Valuations: The fair valuation process would suggest that the individual stock valuations will eventually correspond to earnings growth rates after adjusted for the underlying risk.  Back in 2002, KKD’s 68 PE has been considered excessive even for its 43% revenue growth rate, relative to DNKN’s 27 PE for its 6% growth rate.  Ironically, in the aftermath of 2001’s internet bubble burst, Krispy Kreme as a donut chain was still traded at an internet stock-like PE of 68.  Three years after that 7-quarter mark, KKD lost 70% market value which led to an acquisition by JAB Beech, Inc. in 2016.  In contrast, DNKN gained 50% two years after the 7-quarter mark.

Fig 5a

Do you know which stocks have PEs at 17, 40, and 39?  They are the stocks for Apple (NASDAQ: AAPL), Facebook (NASDAQ: FB), and NVDIA (NASDAQ: NVDA) which are three of the most high-flying growth stocks by today’s standard.  Do you really think that a chicken-wing stock deserves a PE of 52 while DNKN is traded at a PE of 25?

Fig 4a

Based on most earnings-based valuation metrics, WING’s fair value is between $ 20 and $23, while it was traded at $27.79 at the close of 4/6/2017.

Maybe not “Winner, Winner, Chicken Dinner!”

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