FWRG - First Watch Restaurant Group: Growth Story Just Getting Started

2023-03-27 16:40:14 ET

Summary

• FWRG reported its Q4 earnings, capping off a record year of profitable growth.
• An ongoing national expansion alongside same-restaurant sales growth highlights the positive outlook.
• We like the stock which is supported by overall solid fundamentals and well-positioned to climb higher going forward.

First Watch Restaurant Group ( FWRG ) has found success with its "Daytime Dining" concept serving fresh made-to-order breakfast, lunch, and brunch items at nearly 500 U.S. locations. Indeed, the company reported its latest quarterly results highlighted by impressive growth momentum even amid the challenging economic backdrop.

The attraction here is an expectation for accelerating earnings as the ongoing expansion effort has reached a breakthrough level of scale. We like the stock that has already been a winner this year and is well-positioned to climb even higher based on several growth tailwinds and supported by overall solid fundamentals.

FWRG Earnings Recap

FWRG posted $186 million in revenue in Q4 2022, up 14.2% from the period in 2021. This was driven by a 7.7% same-restaurant sales growth while also getting a boost from opening 16 locations during the quarter. For context, First Watch currently has 474 total locations between 366 company-owned and 108 franchise operations across 29 states.

Pricing efforts to manage inflationary input costs worked to generate an operating margin of 0.8%, reversing the -0.7% loss in Q4 2021. The dynamic is also evident in the adjusted EBITDA, up 6.2% year-over-year. For the full-year 2022, total revenue climbed by 22% to $730 million while EPS of $0.12 notably reversed a loss of -$0.04 in 2021 and -$1.10 in 2020.

We can also bring up that the company ended the quarter with $50 million in cash against approximately $100 million in long-term financial debt. In our opinion, the net leverage ratio under 1x is a positive in the company's investment profile.

Overall, the trends here are especially strong considering the positive income that has been achieved while opening 74 locations in the past two years.

For 2023, management is targeting between 45 and 51 new restaurant openings suggesting a new wave of expansion compared to pandemic disruptions since 2020. Longer term, First Watch sees the potential for more than 2,200 restaurants, or 5x from the current level as a multi-decade opportunity.

Management is guiding for 2023 revenue growth between 15-19% as a continuation of 2022. What stands out to us is the adjusted EBITDA forecast to approach $80 million, compared to $69 million last year.

Is FWRG A Good Stock?

When looking at restaurant stocks, the importance of brand momentum and customer loyalty cannot be understated. The ability to open new locations and consistently replicate a winning formula is a feat that is often easier said than done. In this regard, it appears First Watch is doing something right given the operating and financial results this past year despite the headline-making macro headwinds.

We sense that this "daytime cafe" model combines freshly prepared healthy foods alongside traditional favorites and even craft cocktail options are differentiated enough to keep capturing that market white space.

Management shares data that shows each new restaurant location benefits from attractive unit economics with underlying profitability by year two. Favorably, locations opened in the last two years are outperforming system-wide metrics.

According to the consensus estimates, the forecast is for top-line growth to average nearly 15% through the next three years. What we're focusing on is the outlook for EPS to climb by 44% in 2023 to $0.26 and more than double toward $0.62 by 2025. Again, this trajectory is based on ongoing expansion efforts along with a path for firming margins as the cohort of new and recently opened locations reach optimal performance.

In terms of valuation, FWRG trading at a forward P/E of 60x is priced as a growth stock with the outlook justifying the premium. While certainly not the cheapest restaurant name in the industry, we believe FWRG stacks up well relative to its peer group of "emerging dining concept" brands.

For example, FWRG's forward for 18% revenue growth this year is similar to Shake Shack Inc. ( SHAK ) at 21%, Portillo's Inc. ( PTLO ) at 16%, or even Wingstop Inc. ( WING ) at 15%. At the same time, we note that FWRG with an EV to forward EBITDA multiple of 12x trades at a discount to this same group.

In other words, there is a case to be made that FWRG is undervalued with room for its valuation to converge higher relative to other high-growth restaurant stocks. Here we can say that First Watch has the advantage of a strong balance sheet with a stronger earnings forecast this year.

FWRG Stock Price Forecast

We rate FWRG as a buy with a price target of $20.00 representing a 15x EV to forward EBITDA multiple at the top end of the company's 2023 EBITDA guidance.

The stock traded as high as $19.00 back in Q3 last year and our call here is that FWRG will reclaim that level sooner rather than later. In our view, there is room for stronger-than-expected sales trends while the company benefits from lower cost pressures which should translate into higher earnings.

Monitoring points over the next few quarters include same-restaurant sales trends as a measure of brand strength with new and returning customers. We also want to see the operating margin trend higher. The main risk here would the scenario of a more concerning deep recession that would limit sales trends at the consumer level.

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