Wingstop: a wing and a prayer?

Updated: Mar 4

Wingstop, established in 1994 and headquartered in Dallas, Texas, is an American quick-service food chain specialising in chicken wings. Currently the largest ‘wings-focused’ restaurant chain in the world, Wingstop’s 98% franchised store estate numbers 1583 units. With a company long-term goal of 6000 units globally, and a desire to be in the top 10 of global restaurant chains, investors are pinning hopes on Wingstop’s best-in-class franchise economics, strong demand for the core product and impressive central marketing campaigns to keep the store roll-out churning and franchise revenue pouring in. Today, Wingstop announced Q4 2020 and their year-end results, which the market reacted sourly to. Let's take a look at the investment case.

Wingstop's crispy mango habanero chicken wings in Wingstop wrapping on a blue kitchen counter
Wingstop's Mango Habanero Chicken Wings

Wingstop’s business operations can be split into two segments: the central business, which owns the Wingstop brand and delivers on global marketing strategies and owns a select portfolio of Wingstop stores, and the franchisee business, to which revenue is generated from the licensing of the brand, fees from advertising agreements and other fees associated with system sales. Franchise royalties bring in the largest amount of revenue at 43.8%, and this revenue growth is underpinned by consistent growth in franchised units. This revenue stream is also very high quality, as it is a recurring fee from franchisees who have invested an average of $400,000 in their individual unit, making them unlikely to close down their stores and cease royalty payments. Advertising fees make up 30% of revenue contribution, and this is provided again by franchisees paying for coverage from the central marketing schemes and other tailored ads. Lastly, the company owns some specific Wingstop stores, whose revenue totals 26.1%. Only 2% of stores are owned by the company, which provides benefits to shareholders as it keeps the business capital-light, reduces earnings volatility, increases growth opportunity and allows for select investment in the best profit enhancing opportunities.

A pie chart showing Wingstop's revenue as 26.1% coming from the company, 43.8% coming from the franchises, and 30.1% coming from their advertising
Wingstop Revenue Pie Chart

Wingstop is a marketing machine. If you haven’t had the chance to scroll through their social channels, I suggest you take a look. Their brand is in demand, with a key franchisee being hip-hop legend Rick Ross, who also does a great job promoting the brand. Excellent digital marketing is increasingly being linked into their digital order system, a key reason for delivering high levels of same-store sales growth in the pandemic.

At the recent release of Q4 and full-year earnings, Wingstop has had an excellent 2020. Expectations have been high, and a Q4 earnings miss have disappointed the market, but it is important to remind ourselves that the stock is up 200% since March lows, so much optimism has been baked in. Looking at an overview of performance in 2020, I have picked out some key highlights:

  • 17th consecutive year of same-store sales growth (21.4% US)

  • System-wide sales up 28.8% to $2Bn

  • System-wide sales through digital channels reached 60%

  • Doordash partnership critical to delivering 25% of sales via delivery

  • Net new openings of 153 units — 25 of them international

  • Maintained best-in-class unit economics with cash-on-cash returns of 70%

  • 20 million guests in their digital database

  • 13 Ghost Kitchens installed in core markets

  • Revenue attributed to Wingstop at $248m, an increase of 24.6%

To comment on a few of these points, firstly, the track record Wingstop has been able to deliver is phenomenal. To grow same-store sales for 17 years is impressive. Wingstop actually has very few store closures, with a less than 1% store closure rate in the last 5 years — in a recent presentation Wingstop quipped, "If you build them… they grow!". Wingstop is a digital-first business. From the marketing, all the way down to ordering your weekday wings, everything can be facilitated online. The partnership with DoorDash not only cements this digital offering, but Wingstop has also noted it is introducing them to a new customer type, who may not have ordered from them before. The 2020 performance in spite of the coronavirus is testament to Wingstop’s digital innovation. Whilst many hospitality businesses are suffering, Wingstop is facing unprecedented demand. Partly down to its product being a natural complement to sitting on your couch watching Netflix, but also facilitated by its sophisticated omnichannel offering.

Since we are getting into the nitty-gritty of the chicken wing business, let’s discuss a key challenge for Wingstop. The boom in demand for chicken wings has caused a real supply issue. Unlike a boom in demand for a whole chicken, where you could just increase orders with suppliers to produce more chickens, wings are a secondary product of chicken production. Essentially, it is not worth producing an extra chicken for the demand of two extra chicken wings, so supply is somewhat constrained to the existing number of chickens in current production. The rapid increase in demand for wings, which is great for chains like Wingstop, has also, due to constrained supply, caused a rapid increase in price. Wingstop has attempted to mitigate this cost going forwards with contracts with key suppliers, however, it caused a 2.5% cost increase in Wingstop owned stores in 2020, and will continue to be a factor to watch.

Graph showing the cost of chicken wings steadily rising since March 2020, compared to the price of wholesale beef

Image Source: Bloomberg

In terms of financials, Wingstop has some superior qualities to a typically listed business. Its franchise model with light capital requirements delivers a quality revenue stream nicely to the bottom line.

Table showing Wingstop's Financials from 2017 to 2020.

Revenue growth is underpinned by store roll-outs, for which there is much to be continued, and operating income sits at a very attractive 23% average for the last 5 years. The light capital structure enhances the businesses return on capital employed figure (ROCE) which in 2020 hit an impressive 35.6%. Wingstop has little debt and overall financial metrics are in fantastic condition — a rarity in today’s markets. I believe that the simple business model and reliable financial metrics have been amply awarded by the market in terms of valuation.

Wingstop Valuation Table

Looking at valuation, at the market close on 02/17/20, estimates for earnings in 2021 have Wingstop trading at a P/E of 98 falling to 80 times 2022 earnings. This is a very high valuation indeed, and stumbles in quarterly earnings can lead to significant share price volatility. But in fairness to Wingstop, the high valuation is reflective of:

  • The opportunity in unit growth to 6000 premises

  • Quality revenue streams from franchisees

  • Superior profitability metrics

  • Innovations in digital strategy

To conclude, whilst the valuation may be very high, the underlying business is exceptional. KFC has 24,000 stores globally. I personally don’t know of another concept that can deliver similar long-term unit numbers to the industry heavyweights, and I think Wingstop has all the right credentials to pull off such a feat. The Q4 earnings release has dented momentum, and you may be able to pick Wingstop stock up for a much lower valuation in the coming months, but I personally believe in Wingstop's long-term story and will be looking to add to my current holding at these levels.

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For disclosure, The Twenties Trader owns Wingstop stock.