Shares of wings-and-beer hangout Buffalo Wild Wings (NASDAQ:BWLD) took flight this week after an activist investor reported accumulating a 5% stake in the sports bar, making it the fourth-largest shareholder and one which has an eye on shaking things up. And then second-quarter earnings beat Wall Street estimates.
Chickens coming home to roost
Although B-Dubs' profits rose 13% to $1.27 per share, coming in just ahead of analyst expectations of $1.26 per share, revenue couldn't rise enough to meet forecasts. Sales were 15% higher at $490 million, but analysts were looking for around $502 million. The shortfall was due to same-store sales falling for the second straight quarter, dropping 2.1% at company-owned restaurants and 2.6% at franchised outlets. That's worse than what it saw in the first quarter when comps fell 1.7% and 2.4%, respectively. But Buffalo Wild Wings has aggressively raised pricing this year, and consumers in this economically weak period are seeing its wings as more expensive than the competition.
Earlier this year the restaurant reported traditional wing pricing at $1.97 per pound, while menu price increases over the past year had risen 3.1%. This quarter, its per-pound price fell to $1.94, but menu prices continue to rise, as they were up 3.3% over the past 12 months.
Commodity pricing concerns are easing, though, and smaller rivals like Wingstop (NASDAQ:WING) and El Pollo Loco (NASDAQ:LOCO) both said commodity costs fell over the first half of the year and would continue to do so. Although El Pollo Loco has also taken smaller price increases than has B-Dubs, reporting first-quarter hikes of 1.5%, it also continued to focus on developing the value end of its menu.
Ruffling some feathers
Thus, where an activist investor might make improvements at B-Dubs becomes a question. When Marcato Capital Management made known its stake in the chicken joint, it outlined a few areas where it might seek changes, including:
- Strategic alternatives
- Operational or management changes
- Improving invested capital returns
- Capital structure and allocation optimization
- Company-owned and franchised stores structure optimization
Management is apparently listening, because CEO Sally Smith told TheStreet that Buffalo Wild Wings could certainly afford to take on more debt. The site noted B-Dubs has a relatively low 15% debt-to-equity ratio and would soon be outlining ways it could enhance shareholder value.
Previously it's used stock buybacks to boost returns, spending $75 million in the second quarter to repurchase shares, with expectations it would spend as much as $150 million in 2016. But stock buybacks are not a salve, as they artificially boost earnings per share, particularly when there's something wrong internally at the company.
Not that Buffalo Wild Wings has such problems, but it also hasn't offered consumers much new in the way of menu enhancements, so there is little incentive for customers to return to the chain. That makes some of the ideas Marcato offered to boost returns questionable. For example, taking on debt to pay a dividend to investors might mollify them for awhile, but if the underlying issues aren't resolved those feel-good vibes will quickly dissipate.
Ideas by the bucket
Management changes might help, but where, exactly, remains key. Smith has been a fairly effective steward of the chain over the years, so getting rid of her isn't likely something Marcato will pursue, but a seat (or seats) on the board of directors could be.
It may also want to increase the ratio of franchised stores from the current 50-50 split (there are a few more company-owned stores than franchised ones now), as B-Dubs wants to open 40 company-owned stores this year, but just 35 franchised locations in the U.S. (it plans another 15 internationally). Yet burger chains like Wendy's and Burger King have had great success refranchising the company-owned restaurants so that they're almost wholly franchised operations.
As for possible strategic alternatives, while acquisitions are always possible, the company might get more mileage out of shedding its two fast-casual dining concepts, PizzaRev and R Taco. They're not large enough investments to be meaningful on B-Dubs' financial statements yet, but fast-casual dining (and casual dining too, for that matter) are suffering from a major slowdown in sales. Having the wings-and-beer chain focus on its core operations, instead of on vanity projects like upscale pizza and tacos, could be a better use of its time and financial resources.
Buffalo Wild Wings remains a leading sports-bar destination, but it faces some larger challenges that feel-good initiatives and changes around the edges won't satisfy for very long. A wholesale shakeup that ruffles feathers could be good for what's ailing the chicken joint.