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BWLD is not loved and many of our screens are flashing bearish for the stock.  A deeper look at the model yields some rather different conclusions.

Over the past month BWLD is down 6.4% versus the average full service casual dining stock up 7.1% and the company has caught two upgrades from the sell side.  Short interest is on the high side at 14% as a percentage of shares out, but declining steadily over the past two months.  At 6.5X EV/EBITDA, expectations are low for BWLD and a one multiple improvement in valuation implies $6.37 of upside, or 15%, from current prices.

We have been monitoring our screens lately and BWLD was flashing bearish on this name.  Insider selling, for instance, has been on the high side and Keith’s levels also confirmed a bearish outlook so we decided to dig into the model a little further.

I understand the bearish longer-term thesis on BWLD.  It has grown too fast.  I have expressed this view myself at length over the course of the past twelve months or so but the fundamental story over the next couple of quarters looks solid.  Also, pertaining to the pace of growth issue, my ROIIC outlook for BWLD is strong.  In the past two quarters, AUV’s have outpaced comparable restaurant sales partly due to the closure of 8 older underperforming stores and strong performance from store openings. 

On a less positive note, management did mention that franchise comparable restaurant sales were softer in 3Q due to the higher incidence of store openings in existing markets.  They did not refer to this as cannibalization, of course, but it certainly sounded like it to me!

This stock has not been performing strongly of late, relative to its peers, but our model seems to be telling a different story heading into the first half of 2011.  As with any model, the takeaways are only as useful as the assumptions my projections are based on but I am comfortable stating that the company’s 4Q and FY11 guidance may be slightly modest.  Management actually said that they were being conservative with 18% EPS FY11 guidance.  Currently, our conclusions arrive at 4Q EPS of $0.55 versus the street at $0.53 and we are estimating FY11 EPS of $2.55, a 21% year-over-year increase, versus the street at $2.47 and management’s guidance of an 18% year-over-year increase.

My assumptions assume relatively flat-to-slightly improved comp growth on a two-year basis.  For 4Q10, I am at +1% relative to the company’s guidance of at least flat comp growth.  Company guidance here is, in my view, conservative seen as flat comp growth implies a slowdown in two-year average trends of 40 basis points.  Given that October two-year average trends accelerated by 90 basis points, I am at ease with my comp assumption of +1%.  Management commentary around comparable store sales performance in October indicated that October comps were -0.7% but lapped a strong comparison of +5.9% for the same month of 2009.

Remodels are also buoying comparable restaurant sales, lifting comparable restaurant sales by 5% and the company is looking to carry out 20 remodels in 2011.

Here are some factors that are impacting same-store sales in 4Q10: 

  1. Christmas falling on a Saturday - management said could be slightly negative but could not quantify and was not even sure if it would be a negative
  2. BWLD increased media spend significantly in November and December (not reflected in the October numbers, which would suggest trends should accelerate from October, not decelerate)
  3. Slightly lower pricing impact in 4Q of +1.6% vs. +1.9% in 3Q
  4. The bigger picture issue are the trends in CD since October - good not great!

Restaurant margin should continue to increase in 4Q and 1Q as favorable year-over-year wing prices help.  Through the first two months of 4Q, wing prices were down 15% year-over-year (in line with the year-over-year decline in 3Q).  The company should experience the biggest year-over-year favorability in 1Q11 as prices peaked in 1Q10.  The comparison clearly gets more difficult from there and management did state that there is not much visibility on traditional wing prices.  However, given the peak levels reached in 2010, they would still expect slightly favorable prices in 2011.  Traditional wings account for 21% of sales.  Boneless wing prices should be flat year-over-year in 2011 as the company is contracted through March 2012.  Boneless wings account for approximately 19% of sales. 

The company is expecting to pay higher prices for alcohol in 4Q10 and FY11 than it paid in 3Q10 and this increase was highlighted by management as being part of the reason for the upcoming price increase in January.  Together with a new menu rollout in April, the price increase in January will account for a cumulative 2% increase in price for 1H11.  Largely due to that increase in the price of alcohol, there could be additional pressure on COGS in 4Q relative to 3Q, given that the price increase won’t take effect until 1Q11.  Overall, though, I would stress that COGS will remain quite favorable given the year-over-year declines of wing prices in 4Q.

Management is expecting some labor pressure as it expands its Happy Hour test in 4Q and then rolls it out in 1Q11 to all locations.  The company is also investing in labor training to improve speed of service at lunch.

BWLD also guided to some pressure in 4Q on the operating expense line.  Media spend is expected to be up about 25% year-over-year in 4Q10.  The company is expanding their radio presence in November and December (supporting Happy Hour among other things), and this expected to drive the high year-over-year increase in media spend.  2Q and 3Q saw more moderate year-over-year increases for this line item.

In terms of overall casual dining trends, Knapp Track sales trends for the category were disappointing in November, declining 55 bps on a two-year average basis.  BWLD is one of a rare breed in casual dining at the moment as it is looking at COGS favorability over the next couple of quarters.  For competitors depending on sales leverage to drive the bottom line, this latest Knapp data point is certainly bearish.  The risk to our +1% 4Q comp estimate is obviously that the industry may slow from a top line perspective but the COGS favorability means that BWLD is relatively less at risk from this impacting its bottom line. 

I would also refer to the Sanderson Farms 4Q Earnings Call commentary which indicated that demand for prepared foods was strong through the first week of November and then evaporated.  Demand for chicken in general also turned weak and this should benefit BWLD from a COGS perspective.

All in all, it seems that sentiment around this name is decidedly negative.  Insider selling is at an elevated level relative to most of its peers and short interest, while coming down over the past few weeks, remains high at 14% of shares out.  I think there is a strong chance that earnings could surprise to the upside for 4Q and FY11.

Howard Penney

Managing Director