Like Chuck, I'm a student of Peter Lynch. What investor isn't? His classic texts have served as instruction manuals for millions, yours truly included. Wisdom abounds in Lynch's work. "Buy what you know" is certainly his best-known maxim. But I'd argue that the idea that every portfolio needs a regular checkup is just as important. That notion, after all, is the reason I find myself matched up in this duel today.
Confused? Allow me to explain. I invested in Buffalo Wild Wings
Why I invested in the first place
I bought shares of Buffalo Wild Wings because I really liked the growth story. Indeed, the business had seen sequential and year-over-year growth for four of the previous five quarters at the time of my purchase. And while sales were flat sequentially during the June quarter, overall sales were still up substantially on a year-over-year basis.
Expansion, too, was being funded by operations during 2004. Total capital spending on 19 new company-owned stores was $15.2 million plus pre-opening costs of $2.042 million. That's a heady total of $17.242 million. Yet with net income, depreciation, amortization, and deferred taxes considered, Buffalo Wild Wings generated more than $19 million in cash during the year. It's tough not to like a business that can generate big wads of green to fund aggressive expansion, especially when, like Buffalo Wild Wings, you're buying during the company's relative infancy.
Flapping in the wind
If you're thinking the above sounds tasty, I'm with you. Remember: It was the cash flow possibilities that led me to buy last year. What I didn't consider at the time was how substantially Buffalo Wild Wings' business would be affected by forces outside its control. Take chicken wing prices, for example.
According to the most recent 10-K filed, more than 30% of the company's cost of goods sold is attributable to chicken wings. That makes sense, of course. The only problem is that the average annual price per pound of chicken wings has risen from $0.89 in 2002 to $1.52 in February 2005. Yes, you read that right. Chicken wing prices have nearly doubled over the past three years. Fortunately, prices have finally started to decline.
Just how has the price of chicken wings affected the business? We can't say for sure, but Buffalo Wild Wings' cash flow statement, found toward the front of its recently filed 10-Q, shows that operating cash flow declined by more than 33% year over year. That's awful news, especially when you consider that management has said comps will be closer to 4-5% for company-owned stores and 2-3% for franchised locations during 2005, roughly 50% lower than last year.
Still, growth is the issue. Buffalo Wild Wings aims for lots of it. During the quarter, it opened 12 new stores, three of which were company-owned. Not bad, right? Yep, except it's well below target. Management said last winter that Buffalo Wild Wings planned 19-20 new company stores and 45-50 new franchises, or a minimum of 64 new locations. So there should have been at least 16 new stores opened during the first quarter.
In one sense, the smaller number of openings was a good move, given that all of the growth was funded organically. The scenario becomes more problematic, however, when you calculate the cost to open another 16 stores. I'd say that's likely to be close to $14.5 million. Total net income for the final nine months of 2004 was $4.9 million. Let's be aggressive and assume that earnings for the remainder of the year grow by 20% to $5.9 million. That still leaves $8.6 million that must be made up in depreciation, amortization, and deferred taxes if Buffalo Wild Wings is to expand according to plan. Is it possible? Yes. Likely? I doubt it. More likely is that growth will slow.
The Foolish bottom line
Buffalo Wild Wings is a growth stock in the process of hitting the brakes to focus on improving core operations. I think that's smart, and I will continue to hold the shares. But at 35 times trailing earnings and 22 times forward earnings, Buffalo Wild Wings' stock is priced for accelerating expansion. That doesn't appear to be attainable, at least not right now. That may be why roughly 20% of the shares available have been sold short. Should you join the shorts? No. But much better buy-in prices are likely ahead.
Keep up with every step of the duel. Chuck Saletta's bull position started the debate, and rebuttals from Chuck and Tim wrap it up.Once you're done, don't forget to cast your vote for this week's winner.