I love small growth stocks, which is why I was so excited when I heard about Buffalo Wild Wings (NASDAQ:BWLD) on Fool.com. The company operates restaurants that sell beer and chicken wings, and has tons of televisions for those who want to watch live sporting events. What could be easier to understand than what sounds like an upscale sports bar?
The best part is, the company was growing sales and earnings at a fast clip, and they had plenty of room to expand. I owned shares for a while, but then sold when I realized that some problems were cropping up. I’m sorry to say it, but those problems I noticed aren’t getting any better.
The restaurant industry is rife with examples of companies that expanded too fast, or didn’t diversify their menu, and thus failed to live up to expectations. Peter Lynch talked about one example when he compared Fuddruckers, and Brinker International, Inc. (NYSE:EAT), which owns the Chili’s concept. He said that both companies specialized in burgers, but while Fuddruckers stuck with the gourmet burger, Chili’s diversified its menu. Today, Fuddruckers barely lives on under the Luby’s, Inc. (NYSE:LUB) name, and Brinker is one of the better values in the restaurant industry. The moral of the story is a restaurant’s menu must diversify over time.
The reliance on chicken and beef prices is one of the main issues at Buffalo Wild Wings, and also at competitor Chipotle Mexican Grill, Inc. (NYSE:CMG). Both of these concepts are mid-priced eateries, and both battle for the dining dollar of customers every day. In my town, we have a strip mall where customers can choose between Buffalo Wild Wings, Chipotle, or Panera Bread Co (NASDAQ:PNRA). The difference between Brinker and Panera Bread versus Buffalo Wild Wings and Chipotle is the diversity of their menu.
Sales and Earnings Are Up, So What’s the Big Deal?
I know some investors in Buffalo Wild Wings are questioning my sanity right now. They would point to the company’s revenue, which was up 37.8%, and EPS that increased 21.9%. With shares trading for about 21.8 times projected earnings, what’s the problem?
The problem is, these results hide some underlying issues. If you look at Buffalo Wild Wings‘ operating margin, you can see chicken input prices are causing a problem. In the current quarter, Buffalo Wild Wings reported an operating margin of just 7.7%, which was down from 8.43% last year. This isn’t a one-time event either. Buffalo Wild Wings‘ cost of sales has increased from 28.3% in 2011, to 29.4% last December, to 32% in the current quarter.
Chipotle also has challenges with beef and chicken prices, but the company’s efficient operation allowed the company to report an operating margin of 14.62%. Panera’s menu is broadly diversified, and their efficiency in the ordering line leads to an operating margin of 11.33%. Though Brinker’s Chili’s is a sit-down restaurant like Buffalo Wild Wings, the company’s menu is more diversified, and it shows in their operating margin of 8.93%.
More Shares and Slower Growth
Two additional issues facing Buffalo Wild Wings are the company’s management of their share count, and their projections for growth. In the last year, Buffalo Wild Wings’ diluted share count is up 0.84%. This doesn’t sound terrible, until you consider that Brinker, Chipotle, and Panera Bread are all buying back their shares.
