FWRG - First Watch Restaurant: Long Growth Runway

2023-07-20 08:38:10 ET

Summary

• First Watch Restaurant has a long growth runway, considering that it has the potential to increase its number of restaurants from 484 as of end-March to over 2,200 in the future.
• First Watch's favorable store economics, its talent recruitment edge, and the high percentage of at-home dining for breakfast put it in a good position to achieve its long-term growth targets.
• I assign a Buy rating to FWRG stock, as I don't think that its current valuations have fully priced in its long growth runway.

Elevator Pitch

I have a Buy investment rating assigned to First Watch Restaurant Group ( FWRG ) stock. First Watch could potentially have as many as 2,200 restaurants in the long run as compared to its current number of restaurants at below 500. But FWRG's consensus FY 2022-2025 operating earnings CAGR is higher than its consensus forward next twelve months' EV/EBIT multiple now. This suggests that the market hasn't completely factored in First Watch's long-term growth potential into its stock price and valuations. This explains my decision to award a Buy rating to FWRG.

Company Description

Listed on NASDAQ since September 30, 2021 , First Watch refers to itself as "an award-winning Daytime Dining concept serving made-to-order breakfast, brunch and lunch using fresh ingredients" in the company's media releases .

First Watch's Spring Seasonal Menu As An Example Of Its Food & Beverage Offerings

What First Watch's Restaurants Look Like From The Outside And On The Inside

First Watch was started in 1983, and the company has expanded significantly in the past decades. As of March 31, 2023 FWRG had 484 restaurants in 29 states, of which 370 were owned and 114 were franchised, as indicated in its Q1 2023 earnings presentation . Also, about four in 10 of First Watch's restaurants are located in the Southwestern United States, as disclosed in the company's FY 2022 10-K filing .

First Watch's Long-Term Growth Outlook

FWRG has substantial growth potential, taking into account the company's new restaurant opening target and the sell-side's consensus financial forecasts.

In the company's first quarter results presentation, First Watch outlined its goal of a "low double digits" percentage growth ever year for the long run. Specifically, FWRG is of the view that it can grow its number of restaurants from 484 as of end-Q1 2023 to 2,200 and above in the long term.

With respect to the analysts' consensus financial projections (source: S&P Capital IQ ), First Watch's EBIT and normalized net profit are estimated to grow at CAGRs of +53.9% and +49.8%, respectively for the FY 2022-2025 time frame.

I am of the opinion that both FWRG's new restaurant expansion target and the Wall Street's consensus financial estimates are realistic for three key reasons.

Firstly, FWRG's favorable store economics support the bullish thesis of First Watch having ample room for expansion. As indicated in its Q1 earnings presentation, First Watch boasts a "flexible box size of ~3,000-6,600 square feet with an average net build-out cost of ~$0.9M-$1.4M." The relatively small size of FWRG's restaurants imply that it is easier to find new locations for the company's new restaurants as compared to other restaurant operators with concepts requiring larger square footage. Also, the smaller size of First Watch's restaurants means that the capital expenditures needed for new restaurants are comparatively lower than that for bigger restaurants.

Secondly, First Watch has an edge over competitors in recruiting talent, due to the company's focus on daytime dining, or the time period between 7:00 am and 2:30 pm. Having the best talent is of the most important factors in driving a company's future growth. With an increasing emphasis on work-life balance, a meaningful number of workers aren't keen to work on night shifts, and this pose challenges for most restaurants that run for long hours into the evening. This is where FWRG differentiates itself in the eyes of potential employees. In its FY 2022 10-K filing, First Watch stressed that many people are "drawn to our 'No Night Shifts Ever' approach", which is made possible by the company's daytime dining operating model.

Thirdly, FWRG has yet to fully capitalize on emerging trends in the restaurant industry, considering a number of specific metrics. In its first quarter results presentation, First Watch emphasized that "the growing morning meal occasion" is a key growth trend for the company. But "70% of breakfast occasions are eaten at home" now based on research cited by FWRG at Bank of America ( BAC ) Consumer & Retail Technology Conference on March 15 this year. Also, there are opportunities for First Watch to increase its sales by optimizing its new restaurants. As an example, FWRG noted at the mid-March BAC investor conference that it could lift its restaurants' table occupancy rate from 70% to 85% by changing the table layout to cater to weekend diners who tend to come in pairs.

FWRG's Short-Term Outlook Is Decent

First Watch's business performance is likely to be resilient in a challenging economic environment.

The mid-point of FWRG's fiscal 2023 guidance points to a reasonably decent top line growth of +18.0% and a normalized EBITDA expansion of +19.1% for the current year. In the past three months, First Watch's consensus FY 2023 normalized EPS forecast was raised by as much as +25.6% .

I think that First Watch is expected to deliver a decent set of results for the current year despite economic pressures, because of the company's "value-for-money" positioning in the full-service restaurant segment.

At the BAC Consumer & Retail Technology Conference in mid-March, FWRG revealed that its average check size was $15.50,, which it referred to "everyday value for the customer." More importantly, First Watch doesn't compromise on the quality of its food & beverage offerings, even though the prices of its meals are affordable. First Watch specifically emphasized at Barclays ( BCS ) 8th Annual Eat, Sleep, Play Conference (event transcript sourced from S&P Capital IQ ) in November last year that "we make everything fresh to order."

Concluding Thoughts

First Watch boasts good growth prospects in the long run, and its financial results are still expected to be decent in the near term.

I deem FWRG's valuations to be reasonable, as its consensus forward next twelve months' EV/EBIT multiple of 41.2 (source: S&P Capital IQ ) is below its consensus forward FY 2022-2025 EBIT CAGR of +53.9%. As a rule of thumb, a stock is typically judged to be fairly valued assuming that its earnings multiple is equal to its earnings growth rate.

In conclusion, I rate First Watch as a Buy, considering both its long growth runway and its reasonable valuations.

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