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BWLD is one the few restaurant companies that will have commodity pricing that will benefit margins thanks to lower year-over-year wing prices.  In spite of this, I remain concerned about the brand and where it is positioned with the consumer.  The concept continues to underperform other “younger” concepts that are of the same size and competing in a more differentiated part of the restaurant industry.

For certain “growth” restaurant companies, the Hedgeye “sustainability” trends are important metrics to measure how a company is using its cash flow.  With no funded debt and trading at 6.3x EV/EBITDA, BWLD has some attractive attributes.  As always, there is more to the story.        

BWLD LONG-TERM THESIS

The 20% EPS growth guidance for FY10 seems achievable.  The street’s $2.07 EPS estimate implies 22% growth and I am currently modeling $2.11 per share, or about 25% growth.  My estimate assumes 13% unit growth and two-year average comp trends that are fairly even with 2Q10 trends.   I am also assuming that restaurant-level margin growth will be positive in the back half of the year as favorable YOY cost of sales (driven largely by significantly lower wing prices) will be enough to offset the expected higher operating  and advertising costs.

I think it will be more difficult for the company to achieve 20% EPS growth in full-year 2011.  I am currently modeling 15% growth, and that assumes only a modest uptick in two-year average same-store sales trends and nearly 14% unit growth (management said it would provide more details about its plans for unit growth in FY11 on its 3Q10 earnings release date).  That being said, based on our restaurant sigma chart, it looks as though the company has a good chance of remaining in the “Nirvana” quadrant (positive same-store sales growth and positive restaurant-level margin growth) for the next several quarters if comp trends hold steady (but that is obviously a big if).  BWLD needs positive comp growth to offset the growth-related costs inherent in its P&L and comps trends definitely improved more than I was expecting during the second quarter.  It will be important to see if BWLD can maintain this top-line momentum.

Despite slowing top-line growth, the company’s FY10 capital spending is expected to increase 15% to 22% to $85 to $90 million.  Assuming the company again targets 13%-15% unit growth in FY11 (on top of the expected 13% increase in FY10) and an increased number of remodels, this number will likely move higher.  Based on my estimates, capex growth should outpace total sales growth by nearly 3% in 2010 and nearly 5% in 2011.  At the same time, net CFFO (after capex)/net income should move lower.  These two metrics are typically red flags that the company’s current growth strategy is not sustainable.  For now though, EBIT margins appear to be moving in the right direction.  And, during 2Q10, AWS growth outpaced same-store sales growth for the first time in three quarters, which implies improved new unit volumes; though the company’s decision to close a handful of low volume units also helped AWS during the quarter.

I consider return on incremental invested capital to be the best metric to look at when considering the sustainability of a company’s unit growth plans.  After declining in 2009, returns look to be recovering in 2010 to about 30%, which is impressive.  Based on my current estimates, I would expect returns, however, to fall off again in 2011 to a low double-digit range.  Although this still implies positive returns for 2011, I have found that the absolute direction of the trend in returns is the more important indicator of future trends.

BWLD – MIXED SIGNALS - bwld sigma

Howard Penney

Managing Director