Wingstop: Massively Overvalued Despite Strong Growth Prospects (NASDAQ:WING)

Introduction

Wingstop (NASDAQ:WING) is a great business with a solid growth plan laid out for the future, suggesting strong double-digit revenue growth. Shareholders have been rewarded with a 50% surge in the share price year-to-date and over 295% in the past 5 years. The real question is whether this growth in share price can continue. I believe not and will present the reasons why I believe Wingstop is dramatically overvalued at this price in the following paragraphs.

Company Overview

Wingstop is an American casual restaurant chain that specializes in the sale of chicken wings. The first restaurant opened in Garland, Texas, in 1994, and since then, the chain has grown to reach over 2,000 restaurants, with 200 of them being international. Wingstop operates both company-owned restaurants and franchise locations.

The Growth Story

Overall, Wingstop experienced a significant increase in total revenues during the first quarter, with a growth rate of 42.7%. Additionally, same-store sales showed strong growth of 20.1%. However, it is important to consider that these numbers are relative to a low base in Q1 2022, when the impact of Covid-19 was still prevalent, affecting people’s dining-out habits.

In addition to its revenue growth, Wingstop continued its expansion by opening 37 net new stores in the first quarter. The company’s growth strategy primarily relies on opening new locations, and it aims to achieve a total of 240 net new units this year to further drive its growth trajectory. Looking ahead, Wingstop envisions the potential for a global presence with over 7,000 restaurants:

If there is a reason why Wingstop commands a premium valuation, it is due to its growth potential, particularly in terms of expanding its store count in the coming years. This growth trajectory is supported by Wingstop’s franchise model, which helps reduce the upfront capital required compared to company-operated stores, allowing Wingstop to quickly grow its store count.

To justify further their high valuation, Wingstop must combine their growth in store count along with same-store sales growth:

As you can see, same-store sales show remarkable growth over the past 5 years of 49.6%. In this high inflation environment, it is important to understand that a large part of this growth was not from price rises but growth in the number of transactions, as stated by Wingstop’s CFO Alex Kaleida in the Q1 2023 earnings call:

The transaction growth we experienced in the second half of the prior year continued, and the majority of our first quarter comp was driven by transaction growth.

Valuation

Wingstop’s shares have experienced substantial growth over the past five years, driven by impressive growth figures. However, this surge in share price has led to a high forward P/E ratio of 95.7, which significantly exceeds the market average. A comparison of Wingstop’s forward P/E ratio with its competitors Chipotle Mexican Grill (CMG), Wendy’s (WEN), Texas Roadhouse (TXRH), McDonald’s (MCD), and Yum! Brands (YUM) does not instill confidence either:

Click to enlarge

*Taken from Seeking Alpha Data, correct as of 24/05/23

To estimate Wingstop’s fair value, I employed a discounted cash flow methodology. I assumed the company would achieve a 15% compound annual growth rate (CAGR) in revenues between 2023 and 2030, driven by an 11% increase in store count and a steady 4% growth in same-store sales.

Based on an average EBITDA margin over the past five years, I projected Wingstop’s EBITDA margin to be 26%. Although the growth in store count may lead to economies of scale and a decrease in general and administrative expenses as a percentage of sales, I do not anticipate a significant increase in the EBITDA margin since it is already higher than that of its competitors.

We take an exit multiple of 20x EBITDA and assume current cash and debt remains constant. Although this multiple is high with regard to competitors, we believe Wingstop will still have plenty of growth potential in 2030, so a higher multiple can be justified.

For the discount rate, I chose 15%, which represents the minimum rate of return I seek when investing in individual stocks.

Running the model yielded a fair value for Wingstop of $2.0 billion, or $67.23 per share, suggesting a significant downside from the current share price.

Risks

Despite its high growth prospects, Wingstop’s current share price is too expensive for me. Moreover, there are three risks that I find particularly noteworthy for the company:

Firstly, as with any business in the food industry, any food safety issue can have disastrous consequences for the company involved. A prominent example is Chipotle Mexican Grill, which suffered a significant blow to its reputation due to an E. coli outbreak. While Wingstop’s risk is somewhat mitigated by its preference for frozen ingredients over fresh ones, there still exists a potential risk that, if realized, could lead to a substantial decline in share price.

Furthermore, Wingstop’s EBITDA margin of 26% remains higher than that of its competitors. Wendy’s boasts a margin of 22.3%, Texas Roadhouse maintains a margin of 11.4%, and Chipotle Mexican Grill has a margin of 17%. Wingstop’s elevated margin may attract competitors’ attention, and, given that the company lacks patents protecting its flavors or offerings, competitors may be able to offer similar products at a lower cost, thereby forcing Wingstop to reduce its margins to effectively compete.

Additionally, Wingstop faces the risk of increasing chicken prices. The Avian Flu epidemic, which has resulted in the culling of over 58 million birds to prevent its spread in the most recent outbreak, drove up the prices of chicken in both the USA and international markets. Wingstop’s focus on chicken leaves it vulnerable to significant price increases if further outbreaks occur. This risk is highlighted in their annual report for 2022, as quoted:

Additionally, avian influenza, or similar poultry-related diseases, may negatively affect the supply chain by increasing costs and limiting availability of chicken. As a result, we may not be able to anticipate or successfully react to changing food costs, including the price of bone-in chicken wings, by adjusting our purchasing practices, increasing our menu prices to pass along commodity price increases to our customers or making other operational adjustments, which could materially adversely affect our operating results.

In such a scenario, customers may opt for competitors that offer cheaper non-chicken alternatives, posing a substantial threat to Wingstop’s market position.

Conclusion

Wingstop remains a fast-growing chain with strong prospects. To achieve its growth objectives, the company must effectively execute its plan to open new stores both domestically and internationally, and make ongoing investments in the business, which is expected to drive solid earnings growth. However, despite these favourable growth prospects, the company’s current valuation appears excessive, leaving little to no room for further upside potential. As a result, I intend to avoid investing at this time but will continue monitoring the situation in case there is a significant change in valuation.