Buffalo Wild Wings: Serving Up Sizzling Profits

In 1964, so the story goes, Teressa Bellissimo, co-owner of Anchor Bar in Buffalo, N.Y., whipped up a late-night snack of deep-fried chicken wings for her son, Dominic, and his friends. She split and deep fried some chicken wings (discarding the “flapper”), glazed them with her own original recipe hot sauce and served them up with blue-cheese dressing and a garnish of fresh celery, and, as they say, the rest is history.

The proprietor-chef unknowingly invented what would become the ultimate bar food and mass-market American snack that remains a hit to this day at bars, wing joints and restaurants throughout the country.

One enterprise born out of the rising popularity of the wing dish is Buffalo Wild Wings, Inc. (Nasdaq: BWLD). An instant success since virtually the day it opened its first location in 1982 near The Ohio State University campus, the company went public in 2003 and its seemingly-perfect combination of wings, beer and sports has made it one of the top 10 fastest growing restaurant chains in the country.

Based in Minneapolis, Minn., the restaurant owner and franchiser today has over 500 restaurants in close to 40 states, and while soaring commodity prices and economic gloom are taking a bite out of some restaurants’ profits—as Americans opt to cook at home or order more affordable fast food—the casual-dining outfit is clocking impressive revenue and earnings growth in both its company-owned and franchised units.

So how, in an era of high gas prices, slumping home values and the shrinking bank accounts has the company managed to entice people in for a bucket of Buffalo wings with Blazin’ hot sauce? By selling a wildly-popular product and using a smart marketing and well-thought-out growth strategy. That’s how.

In addition to their signature wings and an expanding menu that now includes sandwiches and salads; each family-friendly restaurant has a little something for everyone. There are 20 domestic and international beers on tap, choices of 14 different wing sauces and extensive media centers, including projection screens, three-dozen or more TV screens (showing everything from big games to the Cartoon Network), music, and video and trivia games. The restaurants have moveable furnishings that can be arranged to suit any situation, and offer several convenient dining options: dining tale service, counter service, or takeout.

Despite a sluggish economy and rising commodities, in the second quarter, the business easily beat Wall Street estimates, ringing up impressive same-store sales, or sales at stores open at least a year, and benefiting from new restaurant openings. The company posted net earnings of $5.6 million, a 46% increase over the 2007 period. Earnings per diluted share came in at $0.31, a 41% leap over the same period last year, beating analysts’ $0.27 per share estimates.

After the earnings release, Robert W. Baird analyst David Tarantino upgraded the stock to “Outperform” from “Neutral,” raising his price target to $45 from $34. In an update to investors, Tarantino called the company’s strong sales “impressive” and said he expects the company to have a health second half of 2008.

It’s difficult to disagree with that, considering the second half of the year has been historically better for the bar and grill operator as sports fans drive-up sales while watching NFL and NCAA games on large high-definition displays over hot wings and cold drinks. With football season right around the corner and management planning a slick marketing campaign that includes, for the first time, a national presence with ESPN, CBS Sports Net, the Big Ten Network and Westwood One, the third quarter will likely be another good one.

The wing kings do face certain challenges, like the possibility that suppliers will further raise prices due to the increasing transportation expenses and the cost of chicken, which is tied to the price of corn, an ingredient in animal feed. Though the company has been benefiting from favorable chicken wing prices as of late and the fact that it buys wings at low spot rates instead of relying on long-term supply contracts, analysts have expressed concerns about the future. Raymond James analyst Bryan Elliot, who has an “Underperform” rating on the stock, believes chicken wing prices may jump in the next 6-12 months with a drop in production.

Even so, the company is confident that it will be able to meet its 2008 goals of 15% unit growth, 20% revenue growth, and 25% net earnings growth. Buffalo Wild Wings expects to open 15 new franchised locations and nine company-owned locations as part of its third-quarter expansion. And the company is aiming to increase its restaurant count by another 15% in 2009 in order to sustain its growth momentum, even as a weak U.S. economy is forcing its peers to scale back their plans to open new locations. The restaurateur also plans to expand internationally, but not before 2010.

Buffalo Wild Wings, which carries no debt, has been consistently posting profits in line with or above Street estimates over the past few quarters, and its stock has risen over 60% so far this year.

Against the odds, Buffalo Wild Wings appears destined to take flight and leave investors drooling.

Action to Take:  We are going to do a long options strangle – this is where we buy both a call and a put option at the same expiration date, but the put strike price is below the call strike price.  Since Buffalo Wild Wings has a beta of 1.49 – there is a very good possibility that this stock will fluctuate significantly before the end of the year.

Buy one December 2008 40 call (symbol: BQULH) for every one December 2008 35 put (symbol: BQUXG).  Since these are December options – there should be a great opportunity to profit.

Cheers,

Mitchell Sachs
Senior Equity Analyst, Wall Street Elite