AGB 2022.4 - Wingstop (WING)
Best in Class Growth + Unit Economics
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Wingstop
It’s obvious that Wingstop models many facets of its business after one of the best restaurant franchise businesses, Domino’s (you can read our write-up from 2020 here). With the small size of the restaurants, low start-up costs, best-in-class unit economics, and the heavy investments into the company’s digital strategy, Wingstop has followed much of the Domino’s playbook. Just keep that in mind as we analyze the nuances of the business.
And yes, the valuation of the stock is high. Just a friendly reminder that we generally don't make stock recommendations or comment on valuation.
Wingstop is the leading franchiser of fast casual chicken wing restaurants in the U.S. The company started as a single restaurant in Texas in 1994 and quickly expanded via franchising just three years later. Now, with over 1,700 locations, Wingstop restaurants can be found in 44 states with the highest concentration in Texas, California, Florida, Illinois and Georgia. Almost all Wingstop restaurants are owned and operated by franchisees (98% of the total) and most new locations are opened by existing franchisees (93%). The average franchisee owns 6 restaurants and number of franchisees that own 10+ locations have doubled since 2014.
The Wingstop restaurant concept is to provide fresh (not frozen), made to order chicken wings with 11+ different sauces plus fries and other sides. That’s most of the entire menu. These three types of ingredients make up ~90% of the products sold with the remainder being drinks and desserts. Alcohol only accounts for less than 2% of revenues. Most of the chicken sold are bone-in wings (65%) and the remaining 35% are boneless wings, tenders and thighs. Wingstop can source the boneless wings and tenders at annual contracted prices but the bone-in chicken wings tend to be purchased on market based prices.
Wingstop is similar to Domino’s in many ways. The restaurants are small at just 1,700 sq. ft. and the initial start-up costs are low at $400k. With annual revenues exceeding $950k in the first year and industry leading restaurant level margins, the payback period is ~2 years.
Wingstop restaurants are efficient because the average location can operate near peak volumes with 4-5 workers in the back and can have a weekly roster of 15-20 employees. Part of this has to do with the simplicity of the menu. And most of the orders are eaten away from the restaurant (80% off-premise) in the form of carryout (75%) or delivery. There are only 40-50 total available seats inside the restaurant.
Over the past decade, Wingstop has exhibited strong growth in new units as well as same store sales. With a lot of white space remaining in the U.S., unit growth is the name of the game. Unit growth has been more consistent at an average +13.7% while same store sales growth has averaged +9.2%. There was a slowdown in same store sales growth in 2016/2017, but the company reaccelerated its growth profile with the introduction of national advertising and delivery.
Wingstop competes against other fast casual/fast food chicken focused concepts as well as other food categories like pizza and burgers. Chicken is the most highly consumed protein around the world, so it makes sense that there are so many competitors that are built around chicken. The largest chicken restaurants are Chick-Fil-A (2.8k locations), KFC (4k), Popeyes (3.5k) and ZAXBY'S (>900).
Over the long-term, Wingstop aims to maintain 10%+ annual unit growth and low-to-mid single digit same store sales growth. Included in the same store sales growth assumption is ~1%-2% of price increases. The company tends to operate with a highly levered balance sheet, using most of the excess capital generated on special dividends and acquiring existing locations from franchisees. The company has stated that it feels comfortable at 6x-7x debt/EBITDA.
Why is it a good business?
As a leading franchise concept, the strength and growth profile of Wingstop is heavily dependent on the financial position of its franchisees. With a strong decade of average unit volume (AUV) growth for Wingstop restaurants, franchisees are in a strong position to reinvest capital back into the business. AUVs have increased from $1M in 2014 to almost $1.6M by 2021. Couple this with only moderate increases in start-up costs, return profiles have increased as well.
While the company doesn’t disclose restaurant level EBITDA (to measure franchisee profitability), it’s possible to calculate restaurant level margins for the company owned locations. Wingstop had restaurant level margins for its company owned locations of 25.3% in 2020 and 18.3% in 2021. This decline in 2021 was mainly due to wing price inflation. Wingstop has been consistently close to best-in-class margins along with other high-returning restaurant concept like Domino’s and Chipotle.
The consistently high returns for new restaurant openings and the strong financial positions of franchisees has resulted in more new restaurant locations being opened by existing franchisees. Incremental locations within a region also help with increasing efficiency for takeout and delivery orders. Over 93% of new restaurants were opened by existing franchisees in 2021, up from 76% in 2014.
At the company level, Wingstop benefits from scale advantages. The company has done a good job of pushing the evolution of the company forward on the financial strength of the franchisees. The first benefit is the ability to market through national advertising which is much more efficient than local advertising. Wingstop launched national advertising in February 2017, more than a year earlier than originally planned at the urging of the franchisees. We’ve seen other retail/restaurant concepts achieve better marketing efficiency when reaching national scale like Ulta Beauty, Tractor Supply, Five Below and O’Reilly Automotive.
Prior to the national advertising program, franchisees were contributing 3% of revenues to its advertising campaigns, but most of it was done at the local level. In regions where there were enough franchisees (and locations), co-ops were formed but they still weren’t as efficient as national ads. The contribution to advertising by the franchisees increased from 3% of revenues to 4% in 2019 and will increase to 5% in 2022.
The second benefit is the ability to quickly implement a digital strategy. Wingstop invested heavily in digital starting in 2016 and revamped its website and smartphone app in 2019. A digital order is much easier to execute at the restaurant (vs. a phone order or in person order) because the order flows through the POS system automatically and delivers the ticket to the make table (there are fewer mistakes when inputting the order). Furthermore, Wingstop has more data on the customer (over 25M in the database) for targeted marketing campaigns.
There is also a sales benefit from digital orders. Transactions are $5 more in a digital order on average (was $4 more prior to 3Q 2017) and this reached over $10+ during covid vs. a dine in order. The company quickly reached a digital order mix of 30% in 2018 and that number spiked to over 60% due to Covid. Wingstop has a goal of reaching 100% digitization of its transactions, which will mainly be the result of more delivery and digital order growth and converting in-restaurant transactions to digital over time.
The third benefit is being able to efficiently offer delivery services. Unlike Domino’s, Wingstop has elected to partner with third party operator, DoorDash, for its delivery offering. The company started testing delivery services in Las Vegas in 2017 and quickly saw an uplift in average ticket sizes by 10%. This makes sense as delivery orders are likely larger due to the consumer wanting to lower the delivery fees as a % of the order value. Delivery testing expanded to Chicago and Austin in 2018 and the company had over 94% coverage by the end of 2019. Wingstop estimates that most delivery orders are incremental with just 15%-20% overlap with takeout or dine-in orders.
Returns on incremental capital?
Over the past 9 years, Wingstop has spent 75% of its capital on capex and 25% on acquisitions, offset by sale of assets. Most of the capex spend is related to technology and supply chain investments, as well as spend related to company owned restaurants. Acquisitions are related to purchases of restaurants locations from existing franchisees like in Kansas City and Denver.
The unit economics of a new Wingstop restaurant are best-in-class and have improved in recent years. Domestic AUV has increased from just over $1M in 2014 to almost $1.6M in 2021 (+5.8% CAGR) while costs to open a new restaurant have only increased from $370k to $400K (+1.1% CAGR) over the same time period. Furthermore, first year AUV has increased due to increasing brand awareness (and benefit from fortressing in a region). With first year AUV increasing from $800K in 2014 to over $950K starting in 2019, the unlevered cash on cash return for a new restaurant by year 2 increased from the 35%-40% range since the IPO to over 50% in 2021.
If we assume that restaurant level margins are close to 20% by year 2 with AUV close to $1M, we get to restaurant level EBITDA of $200K. With a $400K investment, it does imply a 50% pre-tax return on capital by year 2. And because the same store sales ramp continues for many years, the returns on capital look even better in future years. The company average AUV is $1.6M and assuming margins close to 25% (though lower in 2021), restaurant level EBITDA would be $400K implying a 100% return on the initial capital investment.
And the ceiling for domestic AUV may continue to increase. Wingstop’s company owned locations have an AUV of $2.2M (much higher than the average of $1.6M) and some of the top locations generate $3.5M in AUV. This difference can be partially explained by the length of ownership of the average company owned restaurant vs. a franchised location. This makes sense as most new restaurant openings are franchised.
The aforementioned continued ramp up to maturity for Wingstop restaurants results in sustained same store sales growth for the company. If new units continue to comp at +8%-10% for the first few years (though that’s changing now that the starting AUV is increasing due to better brand awareness) and the new unit growth continues to be double digits, the percentage of “high comping” restaurants of the total lifts the overall same store sales growth higher than most other restaurant concepts.
We estimate that Wingstop generated returns on incremental capital between 70%-90% over the past 4 years. Similar to Domino’s, because Wingstop is a very successful franchise concept, the incremental returns are very high. The first reason is that the company owned restaurants generate meaningful returns on capital on their own, given the low cost to build and the high restaurant level margins with increasing AUV. The second reason is that the franchise fee revenues are almost 100% margin aside from corporate overhead, interest and taxes.
Reinvestment potential?
There are a few different ways to measure the reinvestment potential for Wingstop. Just looking at the fast food category alone, chicken was a $35B market in the U.S. in 2020. Add in fast casual and casual dining and that number gets much larger. Adding the revenues of the top 12 chicken restaurants in the U.S. (this includes fast casual, fast food and casual dining), gets us close to the $35B number for 2020.
Another way to look at the addressable market is to compare potential units to other successful franchise concepts. At the company’s IPO, Wingstop stated that 2.5k restaurants was the potential for the U.S. market, but that number has moved higher to 4k as of 2021. At this target number, Wingstop would be close to the number of KFCs in the country, 50% higher than the number of Chick-Fil-A’s and still be 33% lower than Domino’s.
At the IPO, the company assumed that a Wingstop location would address a market with ~80k people. With the increasing AUV at some of the more established locations and Wingstop’s entry into delivery, the company is looking to do more fortressing, especially in some of the more mature markets. Fortressing will shrink the geographic coverage that a single restaurant serves, which will lead to more take-out and delivery efficiency (for the customer and the driver). And while Wingstop doesn’t operate its own delivery service, efficiency still does benefit the company in the form of a better served customer, which could lead to more repeat order volume.
International expansion is also an important part of unit growth. Wingstop is available in many countries around the world, like the U.K., Mexico, France, Indonesia, Singapore and the UAE. The company also has plans to expand into Canada, China and other parts of Asia. Wingstop’s plan is to expand in these new regions with master franchise agreements with a minimum number of locations to be opened in a specific time period. Wingstop views the international opportunity to be 3k locations. Specifically for China, the company has hired consultants to develop the expansion strategy for that territory. Wingstop estimates that the China market opportunity is for 1k restaurants.
Each international market is different and some may be challenging to find the right concept or development partners. Even with a successful opening, it doesn’t guarantee that the Wingstop concept would do well in those countries. The company had a setback in the Philippines in 2018, closing 11 restaurants after being open for just 4 years. Also, Wingstop has been in Singapore since 2013 and currently only has 12 locations in the country.
With a reinvestment rate between 15%-25% and a return on capital between 70%-90%, we estimate that Wingstop has increased its intrinsic value between 14%-18% over the past 4 years. It makes sense that the reinvestment rate is low (similar to Domino’s) because there are very few opportunities to put capital to work, other than acquiring or building out company owned locations. And because 98% of restaurants are franchise owned, the company can be comfortable taking on a high level of leverage at 6x-7x EBITDA and giving excess capital back to shareholders in the form of special dividends.
What else is important?
Virtual restaurants
With the rise of delivery apps and services, there are many dark kitchen or virtual restaurant brands that were created over the past few years. Many of these new concepts were chicken focused and owned by a larger established food services company. Brinker International came out with It’s Just Wings, TGI Friday’s with Conviction Chicken, and Chuck E. Cheese with Pasqually’s Pizza and Wings to name a few.
Wingstop also introduced a virtual brand called Thighstop in June 2021. The idea was to offer a very similar menu but with the main protein being chicken thighs instead of wings. This was very well received with >4B social media impressions after the first week of launch.
This benefited Wingstop in two ways. First, it targeted a new set of customers that prefer thighs over wings for their chicken and would be incremental sales for the company. Second, thighs cost less than wings, especially bone-in wings, and command a much higher gross margin than the company average. According to the Weekly Commodity Report from 2021, wing margins on average range between 55%-65%, whereas thigh margins on average range between 73%-80%. This has been also very helpful during the chicken shortage and rising prices of wings in recent months.
Chicken price volatility
Chicken is the largest ingredient category for Wingstop, representing 69% of the cost of goods in 2021. Bone-in chicken wings are especially important as it is the main protein for the restaurant. For some reason (maybe someone with expertise can explain this to me), bone-in chicken wings are available at market price, which means restaurants that serve this item are subject to that price volatility.
There are ways to mitigate this, by entering supply partnerships like Wingstop did with Performance Food Group. But for the most part, prices for this part of the chicken are volatile. The price per pound for chicken wings in 2020 were between $1.80 and $2.30, except for a steep drop during the first few months of Covid. But in 2021, prices for wings jumped from $2.30 to $3.30.
There are, however, other parts of the chicken like boneless wings, whole wings, thighs and tenders that can be contracted out in advance, which reduces price volatility significantly. That’s another benefit for Wingstop introducing the Thighstop concept. As the company gets larger, Wingstop should also do better with pricing, but it just seems like diversifying away from bone-in wings is smart move.
Covid beneficiary?
It’s easy to see that Wingstop has been a beneficiary from Covid. Same store sales growth jumped from +11.1% in 2019 to +21.4% in 2020. The impressive thing is that the company was still able to achieve +8% same store sales growth in 2021, even when lapping the tough compares. That’s partially due to the benefits we discussed early like national advertising, delivery, strong unit growth, etc.
The company did state that Covid likely pulled forward 2 years of performance but that new customers will likely remain sticky. So as long as these customers are incremental and future same store sales growth continues to be positive (consensus is for +4.8% in 2022 and +4.1% in 2023), that premise is believable.
CEO Resignation
On March 14, 2022, Wingstop’s CEO resigned to be the CEO of Salad And Go. We have no insight with respect to the reasoning or timing of the resignation.
Optionality
Geographic expansion is already part of the long-term plan for Wingstop. However, having real success in an international market will take some time and it’s likely that some expansions into new regions will fail. But if the company were to successfully expand into a new market with similar cash on cash returns for franchisees, it would be better that what’s imbedded in the expectations now.
Other than geographic expansion, following the Domino’s playbook would be to bring the delivery service in-house. It would take a bit of capex investment and human capital to create the back-end technology, train workers and optimize delivery times, routes, etc. but it could be worth it to future proof this aspect of the business. Right now, DoorDash may seem like a good partner because of the infrastructure that they provide as well as the quality in service, but there is a chance that changes over time. Furthermore, DoorDash may one day change their take rates as they become a more important partner to Wingstop (if delivery becomes a larger part of the business). To mitigate that risk, it may be worth it for Wingstop to invest in those capabilities now, while they have excess capital to reinvest.
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Epic sir
Nice read