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BWLD reported strong 4Q10 EPS results after the close yesterday, reporting $0.55 per share relative to the street’s $0.52 per share estimate.  Top-line trends fell short of street expectations, however, with company same-store sales growth coming in -0.3% relative to the +0.4% consensus estimate and management’s guidance for at least a flat YOY result. 

Going into the quarter, I thought management’s comp guidance could prove conservative as it implied a 40 bp deceleration in two-year average trends after beginning the quarter strong with two-year trends up 90 bps in October from the end of 3Q10.  Industry trends, as measured by Malcolm Knapp, also slowed during the quarter, down nearly 90 bps on a two-year average.  BWLD underperformed Knapp trends on a one year basis for the first time since 4Q05.  The company still outperformed on a two-year average basis but the gap to Knapp has narrowed considerably (to 3.3% in 4Q10 from 8.9% in 4Q09).

Despite this comp slowdown during the quarter, BWLD is trading significantly higher today (currently +12%), which I would attribute largely to the strong reported same-store sales trends in early 1Q11.  During the first six weeks of the first quarter, company comp growth was +3.8%, implying a 100 bp improvement in two-year average trends since the end of the year.  Management would not comment on whether this comp acceleration is reflective of a sustainable trend for the remainder of the quarter and year, but they did say the comp growth did not include any one-time benefits outside of the company’s being extremely focused and ready for Super Bowl this year. 

BWLD’s 1Q11 comp trends will benefit from both an 80 bp increase in average price during 1Q11 relative to 4Q10 and from the expansion of its Happy Hour initiative from only three markets in 4Q10 to about 65% of its company markets by the end of the first quarter.  That being said, I don’t think the company will be able to sustain the same level of momentum from early in the quarter for the balance of the quarter; though trends should accelerate from 4Q10 levels with increased pricing helping to offset my expectation for a continued slowdown in overall casual dining trends.  I am currently estimating +3.5% company-owned comp growth during the first quarter, which assumes a 60 bp increase in two-year average trends.  I think two-year average trends will be flat-to-slightly down for the remainder of the year, implying about +2.5% growth for the full year.

Restaurant-level margins improved an impressive 140 bps YOY during the fourth quarter as the company continued to benefit from favorable traditional chicken wing prices (traditional wings accounted for 20% of 4Q10 sales).  Cost of sales as a percentage of sales was down nearly 150 bps YOY.  Given that chicken wing prices were down 16% YOY, I was actually expecting this expense line to come in even more favorably, but management stated that the lower wing prices were partially offset by a slightly lower traditional wing sales mix (-1% YOY) and higher beer costs during the quarter. 

The company took a price increase in early January to slightly offset these higher beer costs, but they will continue to put pressure on margins going forward as could a continued decline in wing sales.  It is important to note that overall alcohol sales mix fell to 23% during the fourth quarter from 25% in the year ago quarter, which is not good for margins.  The company is hoping that the expansion of its Happy Hour program will work to once again boost its alcohol sales mix. 

BWLD will see the biggest benefit to its restaurant-level margin in Q1 from an estimated 30% decline in chicken wing prices (prices averaging $1.29/lb during the first two months of the quarter).  Chicken wing prices peaked in 1Q10 at $1.91/lb.  Depending on where prices come in for the remainder of the year, BWLD will likely continue to benefit from favorable prices; though the YOY favorability will lessen as the year progresses.  Increased labor costs will likely continue to pressure margins in early 2011 as the company rolls out its Happy Hour program and invests to improve service during the lunch daypart.   

BWLD maintained its FY11 guidance for 13% unit growth, but is now expecting to open 50-55 new company-owned restaurants relative to its target of at least 40 units outlined on its 3Q10 earnings call.  This new development target assumes a 40-60% increase in new company-owned unit growth from 2010 (total company-owned unit growth +16-18%).  Although the company’s AWS have outpaced same-store sales growth for the last three quarters, highlighting the strength of new unit openings, I am not convinced this aggressive acceleration in unit growth is good for returns.  Management stated that cannibalization negatively impacted quarterly comps during 2010 by about 25-50 bps and would expect that trend to continue in 2011. 

The company justified the acceleration in unit growth by saying, “But we've been gearing up for increased company store growth over the last couple of years. And again once you have that first one or two in a market it's certainly easier to add that third, fourth and fifth because you've got teams in place, you have an ability to hire and train.” Management went on to partially blame its lagging franchisee comp growth on cannibalization in markets such as Texas where franchisees have opened second and third stores in markets that only had one for a while. 

I don’t think it is ever a good sign for returns when management is explaining away sales cannibalization.  In some markets, there just may not be a need for a third, fourth and fifth store.  Based on my assumptions, ROIIC (return on incremental invested capital) should continue to be strong in 2011, but I would expect it to decline from the nearly 30% level in 2010.  The direction of returns is worth keeping an eye on.

Same-store sales growth should come in strong during the first half of 2011 on a one-year basis as YOY comparisons get much easier.  Higher menu pricing, combined with extremely favorable wing prices, will continue to push margins higher during the first quarter, but I would then expect margin trends to decelerate for the balance of the year.

All in, I think BWLD’s earnings results will be in line with the street’s expectations during the first half of the year but could fall short in the back half of the year.  I am currently modeling FY11 EPS of $2.45 (+16.5% YOY) relative to the street’s $2.50 estimate and management’s FY11 guidance of at least 18% growth.  Going into the quarter, I thought management’s FY11 +18% EPS guidance was conservative, but same-store sales trends fell short of my expectations during 4Q10, COGS as a percentage of sales were not as favorable as I was modeling, management guided to some G&A pressure in 2011, primarily as a result of incremental investment internationally and the company will face sharply higher preopening expenses YOY. 

Sell-side sentiment has improved over the last four months as reflected by the 67% of analysts recommending BWLD as a buy relative to only 44% in November 2010.  Although the next two quarters should be fine relative to current expectations, I would expect trends to decelerate in the back half of the year.

BWLD - BUFFALO SOLDIER - BWLD sales vs. margin


Howard Penney

Managing Director