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We have reiterated our long-term Neutral recommendation on Buffalo Wild Wings Inc. (BWLD - Analyst Report), a casual dining restaurant operator, based on its consistent track-record of success, viable business strategies and a debt-free balance sheet. However, increasing wing costs, uncertain economic environment and stiff competition from other casual dining operators, along with budget-constrained customers, are the major concerns.
Buffalo Wild Wings’ second quarter 2012 earnings of 62 cents per share were well below the Zacks Consensus Estimate of 68 cents, but above the year-ago quarter earnings of 58 cents per share. The lower-than-expected result was attributed to an upsurge in wing costs.
Total revenue climbed 29.7% year over year to $238.7 million, but missed the Zacks Consensus Estimate of $240.0 million. Same-store sales escalated 5.3% and 5.5% at company-operated restaurants and franchised restaurants, respectively.
Restaurant operating margin contracted 340 basis points (bps) to 17.5%, owing to a 440-bps hike in cost of sales to 31.6%, arising from an 86% year-over-year surge in traditional wing costs and lower wing-per-pound yield as poultry producers are shifting production to larger sizes in order to maximize protein weight.
In the second half of 2012, management expects a continued rise in traditional wing prices owing to an increase in the price of corn, used in chicken feed, due to the recent drought, as well as modest price hikes in other commodities. The wings’ cost will also remain unfavorable for the third quarter of 2012 as in the first two months of the quarter; the price of chicken wings has averaged to $1.95 per pound as compared with $1.16 in the year-ago quarter.
During the second quarter of 2012, the company also incurred expenses for the roll out of the new point of sale and back office systems at company-owned locations. Similar expenses are also estimated in the third and fourth quarters, as the company continues the roll-out. Additionally, labor costs as a percentage of restaurant sales are also estimated to be slightly higher in the third quarter of 2012, due to an expected increase in training associated with the roll-out of a new POS system and new service strategy to further build the brand.
Pre-opening expenses are also projected to be higher in 2013, related to development schedule. Based on cost inflation, Buffalo Wild Wings also revised its net earnings growth target range to 15% to 20% from previous goal of 20%.
However, company remains focused on combating cost inflation, particularly the persistent high cost of wings through menu price increases and expense control. Overall Buffalo Wild Wings expects menu price increases to run at 3% annualized pace in the third quarter and at 4% in the fourth quarter.
Moreover, Buffalo Wild Wings is beginning to test a different way of packing its wings –which would enable them to reduce the number of wings per order. The company also expects the ongoing sales momentum and unit level growth to overcome cost inflation. Over the long-term, the company expects cost of sales ratio to be in the range of 29–30%.
Same-store sales also remain impressive as it grew 6.8% at company-owned restaurants and 7.3% at franchise locations in the first four weeks of the third quarter of 2012. Comps in the early third quarter have benefited from an extra UFC event, Euro Cup final as well as increased menu pricing in mid-July.
Moreover, comps should be able to continue its solid momentum in 2012, based on incremental marketing (including new radio spots and new television creative), greater focus on NFL draft parties (increasing by 50% vs. last year), higher pricing contribution and increased visibility of the brand due to its first-time sponsorship association with a long-standing college bowling game, which from now onwards will be titled Tthe Buffalo Wild Wings Bowl.
The Buffalo Wild Wings Bowl will be played in Tempe, Arizona on December 29th between the Big Ten and Big Twelve teams. Additionally, an extra Thursday night NFL game in September has also propelled comps growth.
Furthermore, the company is able to attract customers through radio, digital and social media. To increase customer visitation, Buffalo Wild Wings continues to focus on Happy Hour and draft beer sales, gift card sales, remodeling of restaurants, shutting down of underperforming restaurants and new menu offerings.
The company has introduced an online ordering system, new facebook promotion and is also testing the use of interactive technologies, including tablets and smartphones. To enhance functionality, the company is also investing in technology to upgrade its point-of-sale and back office systems.
Additionally, to provide customers with the experience of stadiums in restaurants, the company is focusing on a new design and expects to have two of the new design prototypes built in the Cincinnati and San Diego markets. One location is expected to open in the fourth quarter and the second location thereafter.
Additionally, the company provides ample growth opportunities given its plan of opening 1,500 restaurants in the United States within the next five to seven years and 50 in Canada by 2015. Apart from venturing in Canada, the company has also inked two deals with franchised partners in the Middle East and Puerto Rico to further expand its footprints.
In the Middle East, the company plans to open up to 22 locations across six countries over the next six years and in Puerto Rico, it plans to unveil 4 locations by the end of 2016. Buffalo Wild Wings is also evaluating potential acquisition deals for additional growth.