2023-11-28 10:45:13 ET
Summary
- Wingstop stock continues to rise, up 77% YTD compared to the S&P 500's 19% gain.
- Q3 results showed revenue and net income up 26% and 46% YoY, with same-store sales increasing 15%.
- Despite positive metrics, the stock's current valuation near $7 billion is hard to justify, with a P/E near 100x and P/S of 16x.
- The bull chapter has closed on price performance. I anticipate a return from the make-believe and a harsh re-rating of Wingstop shares.
- Is WING truly overvalued by >100%? The facts are hard to argue otherwise.
Introduction
Stock of Wingstop Inc. (WING) continues to defy all odds, seemingly climbing higher and higher with each passing day. The stock is up 77% YTD compared to the S&P 500's rise of 19%. That's a lot of alpha.
WING reported Q3 2023 earnings on November 1, and the market responded favorably with an 8% post-earnings pop. The results were good with revenue and net income up 26% and 46% YoY, respectively. Also, same-store sales increased 15% over the same period.
WING is operating from a low base, with quarterly revenue of $117 million and net income of $20 million. So large increases in YoY metrics, while positive, should be viewed with this in mind.
Personally, I cannot rationalize WING's current valuation near $7 billion, which represents a P/E near 100x and P/S of 16x. In my opinion, WING is grossly overvalued, and priced as if it's year 2040.
Generally, I'm not someone who recommends shorting stocks, but WING has me reconsidering. In this article, I'll explain why current shareholders should sell-sell-sell before this land of make-believe comes crashing back to reality.
Bearish Point #1: WING is not CMG
Let's start with the notion WING is the younger sibling of Chipotle Mexican Grill ( CMG ). Investors who are bullish on WING love to make this comparison. Not only do the two companies operate very different businesses, but they also serve two very different markets.
WING operates mostly as a franchisor while CMG is a restaurant operator. WING generates revenue by taking a cut of each sale from its franchisees. CMG generates revenue from restaurant sales with a much smaller portion coming from franchise fees.
Americans Prefer Mexican Food
A recent study shows Mexican food is the 2nd most searched and consumed food in the United States with Chinese food taking the #1 spot. Also, if you compare searches for "Mexican food" vs "chicken wings" in Google Trends, you'll notice "Mexican food" has nearly 2x the search volume as "chicken wings."
Mexican food vs chicken wings (Google Trends)
Interesting note - you'll notice searches for "chicken wings" spikes each February which coincides with the NFL Super Bowl.
This data is somewhat subjective, but it does suggest there's a much larger market for Mexican food than there is chicken wings. So, I believe it's reasonable to conclude WING's market is significantly smaller than CMG's, maybe even by 2x. Thus, it's much less likely WING will grow revenue and earnings to a similar level which is likely to limit its market cap long term.
It's possible food preferences of Americans change in favor of chicken wings over time, but the chart above actually suggests the gap is widening. I wonder how much of this may be due to CMG?
CMG Appeals To The Health Conscious Consumer
Another feather in CMG's cap is that it appeals to a broader range of consumers (i.e. the health conscious and the non-health conscious). If you do a quick Google search, you'll find numerous articles and surveys concluding Americans are trending towards healthier eating.
One of the great things about Chipotle is that it appeals to everyone. Health conscious Americans can eat at Chipotle while maintaining a strict diet. And those who could care less about calories dine there too because the food is delicious (I'm probably in the latter group).
I wouldn't say the same thing about WING, which serves primarily fried foods. As such, the health conscious consumer may not even consider WING as an option on "eat out" night.
I believe this too is a limiting factor for WING.
Bearish Point #2: Valuation
In my opinion, companies which are growing revenue and earnings quickly are worthy of a premium. We see this time and time again in the market. Investors are willing to pay a premium today for earnings in the future. But how much is too much?
Market Multiple Approach
One gauge I like to use is the P/E, and the belief a growth stock should be valued at a multiple that's ~2x its annual EPS growth rate. For example, if a company is expected to grow earnings at 18% annually over the next 3 years, an appropriate multiple might be 36x (18 x 2). This isn't exact, but directionally, it makes sense.
Based on the latest estimates for WING, Analysts are expecting earnings to compound at approximately 20% over the next 5 years.
WING Earnings Estimates (Seeking Alpha) WING Earnings Estimates (Seeking Alpha)
With this assumption, a ballpark P/E for WING would be 40x (20 x 2), which suggests a fair value of $112.80 ($2.82 EPS 2024 x 40). With a current price near $240 per share, WING trades 110% above my fair value assessment.
Reverse Discounted Cashflow
We can also gauge whether WING's current valuation is warranted by running a reverse discounted cashflow ((DCF)). This approach won't give a fair value per share, but it shows how WING needs to execute to grow "into" earnings based on its current share price.
WING Reverse DCF (stockinvestoriq.com)
As displayed above, I assess that WING needs to compound FCF at 29% over the next 10 years to justify its current share price. This is assuming a discount rate of 12% and a terminal P/FCF of 20x.
Mind you, WING grew FCF by 20% annually the previous 10 years. So, it needs to add 50% growth to that performance every year for the next decade. This seems like an extremely high bar and highly unlikely.
Not Even CMG Was So Richly Valued
Back to our CMG comparison. Other than 2 outlier events, not even CMG was so richly valued (P/E of >100x). Since IPO'ing in January 2006, there have been 2 instances where CMG's P/E spiked above 100x for an extended period. These are:
- An E. coli and norovirus breakout in 2015 caused earnings to tank, spiking CMG's P/E above 400x. This weighed on the stock for quite some time.
- The March 2020 Covid crash negatively impacted EPS resulting in 1% growth over YoY.
Other than these 2 outlier events, CMG's P/E has averaged around 55x since 2009.
CMG Historical P/E (Seeking Alpha)
Also, if you compare WING at a $7 billion market cap to the couple times CMG was at a $7 billion market cap (early 2010 and early 2018), you get two very different pictures.
WING vs CMG (Author's data)
Take a look at WING's financials compared to CMG's. Even during the Great Financial Crisis, CMG was generating 4x the revenue with >2x the profits and cashflow as WING. Fast forward to 2017 and those metrics are even greater.
So, please tell me. Why does WING deserve to trade at a valuation that's 2x that of Chipotle?
Bearish Point #3: Too Much Debt, Not Enough Cashflow
WING currently has $712 million in long-term debt with only $78 million in cash and cash equivalents. The company hasn't been shy in issuing new debt either, having compounded it at nearly 22% since 2013. This is the same rate at which it compounded revenue over the same period.
WING Long-Term Debt (Seeking Alpha)
I wouldn't be concerned with the amount of debt on the balance sheet if WING had enough cash or cashflow to cover it timely. Personally, I like companies with enough cashflow to repay all long-term debt within 3-4 years. I learned this from Mary Buffett's book, "Warren Buffett and the Interpretation of Financial Statements."
For the trailing-twelve months ('ttm'), WING generated $73 million in FCF which is the high water mark for the company. It would take WING nearly 10 years to pay off its long-term debt on the basis of recent FCF.
Based on previous actions, I could see WING issuing more debt to pay off its current debt. Sort of like using the Visa to pay off the Mastercard.
Bearish Point #4: WING Can't Afford Share Repurchases
This point relates closely to bearish point #3. In August 2023, WING authorized a $250 million share repurchase program. And in its Q3 2023 earnings report, the company shared it repurchased $125 million worth of stock at an average price of $165.30.
This begs the question, if WING is generating less than $75 million in FCF annually, how can it afford to repurchase $250 million in shares? The answer - WING is financing its share repurchase program, which helps explain the growth in long-term debt.
Also, what does it say about the company's management if they're willing to grossly overpay to repurchase shares of its own stock? Surely executive leadership understands WING is way overvalued.
What other types of capital allocation decisions might they make?
The Catalyst
I think we've established the bearish thesis on WING. Even so, the stock continues to climb. What will be the catalyst to cause a re-rating in the share price? A couple things come to mind.
The first, and most likely, catalyst to knock WING off its pedestal is an earnings miss or downward guide from management.
In recent months, the market has been unforgiving when companies miss on earnings or revise downward. Personally, I received a gut punch a couple weeks ago when Paycom Software (PAYC) dropped 40% in a single day after posting earnings (ouch)!
If WING misses or comes in short of Analyst's expectations, that could be the first domino to cause the stock to fall.
The second, and less likely, catalyst is a food safety or bird flu-type event. This would be similar to the E. coli incident experienced by CMG. When cooking chicken, Salmonella poisoning is always a risk. Or if there happened to be an outbreak in bird flu or similar type disease, this would disrupt WING in a bad way.
This probably isn't very likely to happen, but it can't be ruled out. And I doubt the market would respond favorably.
Bottom Line
The run up in WING has been so unjustifiable it had me wondering if it was in a short squeeze. As of this writing, short interest is just under 8%. The stock has been rallying for weeks so I doubt that's the case, but the performance has been shocking.
The bottom line: get out while the getting is good. With a sky high valuation, I don't know what more you can expect as an investor. The bull case for WING hinges on multiple expansion on a multiple that's already grossly expanded. Or the belief WING is the next CMG, which clearly it isn't.
If I were a shareholder, I'd de-risk for certain. Common sense says there's a lot more downside risk than upside, simply by multiple contraction which seems inevitable.
If you caught the ride on WING, congratulations! But don't get too greedy living in the land of make-believe. You're sure to be woken up soon.
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Wingstop Is Not Chipotle Mexican Grill - Short Opportunity