Shares of Wingstop Inc. (WING, Financial) have been on a tear over the past 12 months, soaring by 100% from $178.70 to $357. Known as a formidable compounder, the restaurant chaing has rewarded long-term shareholders, with its share price skyrocketing more than 1,000% over the past decade. This remarkable growth translates to a compounded annual return of 32.20%.
However, given the significant run-up, Wingstop appears to be overvalued currently. I would prefer to wait for a pullback before initiating a long position.
Consistent revenue and operating profit growth
Wingstop is the largest global fast-casual chicken wing chain, operating more than 2,200 restaurants around the world. Its main business model is franchising. Independent franchisees own and operate around 98% of the total company's restaurants. As a franchisor, Wingstop generates most of its revenue from royalties, franchise fees and advertising fees. This franchise business model, characterized by low capital expenditures, provides a solid foundation for the company to maintain a sustainable operating margin and achieve a high return on invested capital.
Most of its sales, $207 million, was generated from royalty revenue and franchise fees, accounting for 45% of total revenue in 2023. Advertising fees were the second largest revenue source, generating $157.14 million and representing 34.2% of the total. Sales from company-owned restaurants contributed approximately $95.84 million.
What impresses me is the company's consistent growing revenue and operating income every single year. Its revenue has increased from $59 million in 2013 to $460 million in 2023, while the operating income rose from $14.90 million to $112.70 million over the same period. The business is quite profitable and predictable, with high operating margins. Since 2013, Wingstop's operating margin has stayed in the range of 21.50% to 26.80%.
20-year streak of same-store sales growth
In the restaurant industry, the concept of "same-store sales" is quite important. It evaluates the sales levels of a company's restaurants that have been operating for at least a year. This metric helps distinguish whether the business's growth is organic, coming from existing stores, or if it results from opening new stores. Wingstop has also consistently grown its same-store sales year over year. 2023 marked its 20th consecutive year of same-store sales growth.
During the Covid-19 pandemic in 2020, Wingstop found a way to keep growing its business. The company decided to close its domestic dining rooms and only offer carryout and delivery services. As a result, it still delivered growth in revenue, operating income and same-store sales. The 20-year consistent growth in same-store sales, especially during the challenging times of the pandemic, demonstrates that Wingstop's management is quite capable of efficiently adapting to the fast-changing business environment to maintain customers' loyalty and business growth.
Improving ROIC
Wingstop appears to be increasingly efficient in capital allocation. Its return on invested capital has consistently improved, rising from only 8.32% in 2013 to 33.79% in 2023. This improvement indicates the gap between profitability growth and capital expenditure growth is widening. As the franchise model achieves economies of scale, Wingstop requires minimal investment to expand the business and grow its profits, thus generating profitable returns.
Cash flow is on the rise
Along with increasing revenue and operating income, Wingstop has consistently generated positive cash flow. Both operating cash flow and free cash flow have shown an upward trend. The operating cash flow surged from $10.91 million in 2013 to $121.6 million in 2023. The free cash flow followed the similar trend, increasing from $8.76 million to $80.77 million, delivering a compounded annual growth rate of nearly 25% over the past decade. During this period, Wingstop experienced declines in free cash flow in two years, specifically 2019 and 2021. The decline in 2019 was attributable to the company's $18.30 million purchase of an office building. In 2021, the decrease resulted from increased capital expenditures on construction in progress and a reduction in the net advertising fund, which finances various advertising campaigns for the brand.
Leveraged balance sheet with special dividend payments
Upon first glance, investors might be quite concerned about the significant negative shareholders' equity of $457.40 million at the end of 2023. This negative equity was primarily due to a nearly $460 million retained deficit within its balance sheet components. Such figures could lead to the misconception that Wingstop has accumulated substantial losses over the years, which is not the case.
A deeper investigation reveals the retained deficit and the shareholders' deficit were mainly due to the company's consistent dividend payments to shareholders. Since 2017, Wingstop has returned more than $556 million to shareholders in the form of dividends. The dividend per share has increased from 14 cents in 2017 to 82 cents in 2023, while maintaining a reasonable payout ratio between 0.17 and 0.58.
However, Wingstop has also consistently paid out special dividends, distributing $6.20 per share in 2018, $5 per share in 2020 and $4 per share in 2022. What concerns investors is that most of these special dividends were not financed through the company's earnings, but through secured loans.
As of December 2023, Wingstop had $90.20 million in cash and cash equivalents. However, its long-term debt stood at a staggering $712.30 million. This debt is not due until 2027, with a principal payment of $472.80 million, and 2029, with a principal payment of $239 million. The ratio of debt to operating cash flow was quite high at more than 5.80. Given the current cash reserves, current dividend payment trend and the rate at which operating cash flow is generated, I think Wingstop will need to refinance most of this debt through external financing when it matures.
Significantly overvalued
Let's conduct a discounted cash flow analysis to determine its valuation. I assume Wingstop can maintain a high compounded annual growth rate of 25% per year for its cash flow, after which the terminal growth rate decreases to 3% in subsequent years. Applying a 10% discount rate, we find that Wingstop's enterprise value should be approximately $5.62 billion. After adjusting for net debt of $622 million and with the total shares outstanding of nearly 30 million, its intrinsic value is calculated to be around $167 per share. This is 54% lower than its current trading price, indicating the market significantly overvalues the company at the moment.
Key takeaway
Wingstop has exemplified the model of a high-growth, profitable and efficient capital allocator, captivating investors with its extraordinary journey of an over 1,000% share price increase over the past decade and a compelling 20-year streak of same-store sales growth. The franchising model has served as a solid bedrock for sustainable operating margins and high and sustainable ROIC, producing robust cash flow with minimal capital expenditures. However, Wingstop has several potential challenges that raise concerns. Those are a highly leveraged balance sheet and special dividend payments financed by external debt. Moreover, based on my calculations, Wingstop is currently extremely overvalued. As a result, I would rather wait for a better price before initiating a long position.
