Wild Wings still flying above rest of the flock

Article by: CHRIS SERRES , Star Tribune
Updated: March 28, 2009 - 4:36 PM

Shares of Buffalo Wild Wings may be overcooked, as soaring wing prices and a recession threaten to take a bite out of the fast-growing restaurant chain's profits.

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The crowd at a Buffalo Wild Wings often leans toward young male sports fans. In this Roseville restaurant were Roseville High School students Kyle Matti, left, Ben Podobinski, Ryan Yungers and Matt Mayr .

Photo: Marlin Levison, Star Tribune

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There are 59 television screens at the Buffalo Wild Wings restaurant in Eagan, and, appropriately, on a recent weeknight not a single one is tuned to a channel with news of the troubled economy.

After all, this St. Louis Park-based bar and grill chain, which features a no-nonsense menu of chicken wings, beer, finger food and sandwiches, has seemed to operate outside the normal laws of economic gravity of late.

At a time when crippling job losses and plunging 401(k) values have forced economizing families to stop eating out, Buffalo Wild Wings continues to generate sales that most restaurant chains can only dream about. Its stock has shot up 70 percent since it announced surprisingly strong fourth-quarter earnings on Feb. 11 and said sales at restaurants open at least a year had increased 4.5 percent. That was dramatically better than the casual dining sector as a whole, which saw a 6.3 percent decline in the same quarter, according to Knapp-Track, a closely watched survey of casual-dining chains.

All of which has earned the beer-and-wing chain gushing praise from many Wall Street analysts, who argue that it has positioned itself to do well in a tough economic environment by expanding its low-price menu and through more aggressive advertising during national sporting events, such as the NCAA Basketball Tournament.

"Hands down the best fundamental story in casual dining," declared a Jefferies & Co. analyst in a research note. "We think a 'blazin' performance should not go unnoticed," added investment firm MKM Partners, referring to the chain's trademark "Blazin'" hot sauce.

But not everyone is convinced chicken wings and beer are "recession proof," as some industry observers maintain, or that Buffalo Wild Wings' stock deserves its lofty valuation. And despite its recent runup, closing at $37.35 on Friday, it still hasn't recovered all the ground lost since September, when it traded at more than $43 a share.

An unusually high 35 percent of its common shares are held by so-called "short sellers," who bet on a company's stock going down -- not up. One major reason for short sellers' pessimism: Wing prices.

Feed and fuel more costly

Soaring costs for chicken feed and fuel forced chicken producers to shutter plants last year, while exports soared. Pilgrim's Pride, one of the nation's largest chicken producers, filed for Chapter 11 bankruptcy protection in December. The combination of rising demand and constrained supply fueled fears of a chicken wing shortage this winter, and prices have remained high.

On March 20, the wholesale price of chicken wings hit $1.49 a pound, up from $1.03 a year earlier, according to the United States Department of Agriculture. Normally, wing prices spike during the winter and fall back again in the spring and summer, after the football season ends and demand cools. But poultry experts say that may not happen to the same degree as years past, largely because fewer chicken producers continue to breed fewer chicks.

The number of broiler chicks placed for production has fallen for 35 consecutive weeks -- a decline that's "virtually unprecedented," said David Harvey, an agricultural economist at the USDA. "You can't turn this ship around on a dime."

For now, there is little that Buffalo Wild Wings can do to avoid this wing inflation. That's because, last March, the company's management, led by chief executive Sally Smith, decided not to hedge against rising prices by purchasing wings under long-term contracts. The previous year, the company had locked in prices at $1.23 a pound under a one-year contract.

Smith said in an e-mail the company has not hedged wing prices for 25 of the last 26 years. "We have found this to be beneficial to us," she wrote. "Wing prices fluctuate every year. We plan for this and expect it. ... This is something that we, of course, monitor very closely, and at this point remain very comfortable with."

Still, analysts say the lack of hedges could pose a serious drag on bottom line profits. Chicken wings accounted for 21 percent of the company's cost of sales last year. According to analysts, every 10-cent increase in wing prices costs the company about eight cents in earnings-per-share.

If wing prices were to remain at current levels for the balance of the year -- a scenario some poultry experts described as unlikely but possible -- it could eat away about 22 cents from the company's annual earnings per share. That is about 16 percent of the $1.37 per share that it earned last year.

Large Ohio presence

To be sure, Buffalo Wild Wings can try to maintain its profit margins by raising prices for food and drinks in its 570 restaurants nationwide. Last year, the firm upped the price of wings on its Tuesday and Thursday night promotions. However, price hikes will become more difficult if layoffs continue to accelerate and consumers retrench, some analysts warned.

"Investors don't like uncertainty, and this is an area of uncertainty that makes some people uncomfortable with this stock," said David Tarantino, a Robert W. Baird & Co. analyst who has an "outperform" rating on the stock.

Another source of investor concern is the chain's large presence in Ohio, a state severely hurt by the recession. The first Buffalo Wild Wings restaurant was opened next to Ohio State University in 1982, and about 86 (or one of eight) of the company's restaurants are in the state. Last year, the restaurants in Ohio accounted for nearly 14 percent of the company's sales.

The unemployment rate in Ohio has soared to 9.4 percent in February from 7.4 percent in December, and there are some parts of the state where the jobless rate exceeds 13 percent, according to the U.S. Bureau of Labor Statistics. Buffalo Wild Wings also has a high concentration of restaurants in Indiana and Kentucky -- two other states hard-hit by layoffs.

"Challenging economic conditions in this tri-state area could have a meaningful impact on the company's performance," warned Dougherty & Co. analyst Greg McKinley, in a note to investors last week.

Yet despite such worries, the company's relatively rich stock valuation indicates investors are still counting on the company to outperform its rivals in the casual-dining sector. Its stock is trading at 26 times this past year's earnings per share. That's 40 percent higher than the average price-to-earnings multiple for the restaurant industry as a whole.

Fueling this enthusiasm are recent moves by the company to freshen up its menu and bolster its national advertising. New offerings include barbecue nachos, jalapeno kickers and so-called "flatbreads," which resemble pizza.

The company also doubled spending on national TV advertising during this year's NCAA tournament, with offbeat television spots aimed at its core customer base of young males. In one ad, Buffalo Wild Wings customers insist they don't want a basketball game to end, so the bartender sends a signal to a cameraman at courtside, who blinds a player with an oversized flash and sends the game into overtime.

More than a sports bar

"Their advertising has really done a superb job of driving home the idea that Buffalo Wild Wings is all about the energy and environment of being there to watch a game," said Destin Tompkins, a restaurant analyst with Morgan Keegan & Co.

The company carefully attempts to broaden its sports bar image and appeal to everyone from families to high school students looking for alternatives to the mall. Most of the main dishes on the menu can be had for less than $8, and all kids meals are less than $5. "They have a menu and pricing that really resonates with a broad cross-section," Tarantino said.

On a recent weekday evening, it seemed that much of the adult population of Eagan was eating at a local Buffalo Wild Wings. At various tables sat members of the Eagan High School marching band, a group of male hockey fans cheering on the Minnesota Wild, and families with children taking advantage of the restaurant's Wednesday night deal of 99 cents for all kids' meals.

At the center of the dining area sat Sam Gorr, 26, a University of Minnesota architecture student who was trying to finish a paper on the history of the Weimar Republic. Around him was a pile of papers and books, including a thick one entitled, "A History of Modern Germany Since 1845." A restaurant employee had hooked his laptop to a distant outlet with an extension cord.

"The service is excellent, and it has just the right amount of ambient noise that I can focus," Gorr said. "Plus, you've got beer and reasonably priced food. What more can you ask for?"

Chris Serres • 612-673-4308