Wingstop (NASDAQ:WING) has seen its share price soar in the last five years since its IPO, more than tripling from $30 per share in its first days of trading to over $90 as of this writing. The chicken wing specialist, whose mission is to "serve the world flavor," has set its sights to become a top 10 global restaurant brand. The company's expansion has been swift -- at the end of 2018, it had a total of 1,252 restaurants. By the end of 2019, the company had 1,385 locations, good for a 10% increase in total store count in just a year's time.
Domestic same-store sales growth for the fiscal fourth quarter hit 11.1%, significantly better than same-store sales growth of 6.0% in the prior-year period. Preliminary results put full-year revenue growth at 20.1% year over year. For the first nine months of the year, the company enjoyed growth in both royalty revenue (around 98% of Wingstop's restaurants are owned and operated by independent franchisees) and company-owned restaurant sales, but net income for the period fell 9.7%.
Though growth has been stellar for Wingstop thus far, here are three reasons for investors to be wary.
High debt level
Wingstop has been piling debt onto its balance sheet in order to grow. As of Sept. 28, 2019, its cash balance stood at $9.5 million, while total gross borrowings amounted to $316.3 million. Though the company is generating positive free cash flow ($6.5 million for the first nine months of 2019, down from $23.1 million during the same period a year ago), Wingstop's $55 million of adjusted EBITDA in the trailing 12-month period leaves it with a sizable debt-to-EBITDA multiple of nearly six times.
Interest expenses ballooned from $6.6 million in the first nine months of 2018 to $12.9 million the following year and claimed more than one-third of operating income. The company needs to rein in its debt, before those obligations erode more and more of its net income over time.
Wingstop has demonstrated an impressive ability to grow rapidly within the restaurant industry. The company started out with a total of just 614 stores back in 2013, 21 of them international and 593 domestic. Within five years, the number of stores had grown to a total of 1,252, with international stores rising six-fold to 128. The company is relying on a three-prong strategy to reach an eventual 6,000 locations, a very ambitious target by any standard as this means an almost five-fold increase from the current store count.
Obviously, investors have bought into the hype, pushing valuations up to stratospheric levels. Wingstop is trading at around 110 times forward earnings estimates and 15 times trailing 12-month revenue, levels that can only assume the most bullish case possible for its expansion year after year, with nary a hiccup or problem. Investors need to ask themselves whether Wingstop's long-term vision is actually achievable, or even then, whether this nosebleed valuation makes sense given analysts' estimates for 20% annual earnings growth over the next five years (and just 15% annual growth on the top line).
A shift in dietary preferences
There has been a noticeable shift in consumer food preferences in the last few years as they move away from meat-based products. In addition, a wave of "healthy lifestyle" campaigns have also descended upon us, pushing many people toward a routine that includes both diet and exercise. In fact, the shift has even caused plant-based food companies such as Beyond Meat to hit billion-dollar valuations, even though the company has yet to turn a profit.
With Wingstop specializing in fried chicken wings, this goes against the trend of the new decade and may work against the company in the future. Even Tim Hortons, one of the brands under Restaurant Brands International, has started to add meat substitutes to its menu. If Wingstop does not cater to such emerging trends, it may find itself left behind.
Not as rosy as it seems
Wingstop may offer a unique investing proposition compared to its competitors in the casual dining space, but its premium implies that it is one of the best restaurant stocks to own. Is that the case? Consider Yum! Brands, which is a massive operation with not only a more reasonable valuation around 25 times forward earnings but also a long track record of successful execution and brand recognition around the globe.
For those who cannot resist the allure of Wingstop's aggressive expansion and growth, take note that even the slightest hint of a slowdown could result in the stock's wings being clipped, and the fall back to earth will likely be quite painful.