Source: Buffalo Wild Wings

Something didn't add up in Buffalo Wild Wings' (NASDAQ:BWLD) latest quarterly report.

Revenue surged higher by 20% as B-Dubs tacked on more shops to its store base, improved sales at existing restaurants, and delivered a hefty menu price increase. You'd think that higher prices and more customer traffic would have powered strong profit gains. But no, earnings hardly budged, ticking up by only 2%. The sluggish growth is partly thanks to rising labor costs -- but the main culprit was increasing chicken wing prices. Those jumped by almost 50%, which sent B-Dubs' food cost soaring from 28% up to 30% of sales.

The big risk
Buffalo Wild Wings' management names "fluctuations in chicken wing prices" as the single biggest risk to earnings. "If there is a significant rise in the price of chicken wings, and we are unable to successfully adjust menu prices or menu mix or otherwise make operational adjustments to account for the higher wing prices," management warns in its 10-K, "our operating results could be adversely affected."

Investors saw that scenario play out this past quarter as 41% higher chicken wing costs pushed operating margin down by a full percentage point to 6.6% of sales. 

Sure, every restaurant has to deal with food price swings. Chipotle, for example, is currently paying more for beef and tortillas, which kept its costs at a whopping 34% of sales in the first quarter. In past quarters it has been everything from avocado to sour cream to tomato prices that crimped the tex-mex chain's profitability.

But the difference for B-Dubs is that its operations are unusually dependent on the price of just one ingredient, the chicken wing, that happens to swing wildly from one year to the next. Chicken wings account for roughly one-quarter of the company's entire cost of sales each year. And the price of that ingredient has ranged from as low as $1 per pound in 2011 to over $2 per pound in 2012. 

Source: Buffalo Wild Wings annual report.

That heavy exposure can be nice when prices are swinging in your favor. In fact, chicken wings were 12% cheaper in fiscal 2014, which helped B-Dubs' book an incredible 32% earnings pop. But the company (and investors) would prefer more certainty about profits and cash flow, even if it means having to close the door on any further wild earnings jumps like that.

What B-Dubs is doing about it
So management is working hard to shrink the impact of wing price changes on its operations. B-Dubs already took a huge step in that direction by moving to a weight-based (as opposed to a count-based) ordering system in 2013. The switch means that B-dubs can't be hurt anymore by shifting per-piece wing weights, as it now sells them to customers on the same basis that it buys them from suppliers. 

Source: Buffalo Wild Wings investor presentation.

More recently, B-Dubs has secured long-term pricing contracts that cover the majority of its chicken wing supply. The agreements kicked in during the current quarter and, while they won't bring costs down, they do promise to "narrow the range of cost per pound that [the company] will pay when traditional wings are at historically high and low market prices," according to management. 

That's good news for investors, because chicken wing costs are trending higher again in the second quarter. They were up 25% through the end of April. That's a relief from the prior quarter's 41% jump, but it should still push costs significantly higher.

After that, management is betting that prices start dropping again in the second half of the year. It's likely no coincidence that that's the time Buffalo Wild Wings expects to book the majority of the 18% earnings gain it has forecasted for the 2015 fiscal year.

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