Wingstop is down 26% from its highs and is time to scoop up shares. Here's why

2023 has been a great year for the restaurant industry. The higher-than-expected consumer resilience and the continued growth of the US economy have benefited restaurant brands, as their sales are closely tied to discretionary spending.

Chipotle ($CMG), one of the top restaurant stocks on the market, has rallied 40% this year due to continued rapid growth. Wingstop ($WING), another rapidly growing restaurant chain, has also performed well this year. Between January and May, the stock rallied 60% and hit new record highs, but it has pulled back since then. Currently, WING is up by 'only' 20% this year.

The stock has tumbled 26% since May, as chicken wing prices have started to rise again – they've surged over 30% in the past few months. As the main product on the menu, wing price fluctuations directly impact Wingstop's profitability. But the recent drop is just an overreaction as the company is diversifying its menu by adding products with more predictable pricing and using advanced analytics to predict wing prices.

The last time the stock fell due to wing price inflation was in early 2022, but that proved to be a unique buying opportunity. The current dip is giving investors another chance to buy one of the top restaurant names on the market at a discounted price. Here's why.

An Asset-Light Tech Company

To the casual observer, Wingstop might seem like just another restaurant chain, but the reality is quite different. Wingstop is actually an asset-light tech company that generates high-margin revenue. This is why $WING has outperformed all other restaurant stocks by a wide margin over the past eight years. The $WING performance below doesn't even include dividends, and Wingstop has paid fat dividends as a public company.

The reason WING has been able to deliver such strong returns is its unique business model. Only 2% of the restaurants are owned by the company, with independent franchisees owning the rest. This approach allows the company to maintain simple and capital-light operations. Wingstop primarily oversees the brand strategy that its partners follow and collects high-margin royalty fees based on sales percentages. This strategy has allowed Wingstop to build a restaurant brand with world-class unit economics and deliver great shareholder returns.

The creation of strong shareholder value is likely to continue in the foreseeable future, as all the company's metrics are at all-time highs, and the growth outlook remains promising. Wingstop is the leader in same-store sales (SSS) growth, the most important metric in the restaurant industry. As you can see below, it has achieved 18 consecutive years of positive SSS growth, the highest among any other publicly-listed restaurant brand.

They are currently in their 19th consecutive year of SSS growth, which is an impressive feat and shows that, regardless of the overall economic climate, WING appears to be totally resilient. This is because Wingstop is not a regular choice for most customers; rather, it's seen as an indulgent treat they don't forego even during tough economic times.

As a tech company, Wingstop uses data and digital strategies to increase average customer spending per order and overall spending over time. The Wingstop website and app are two of the main digital drivers for boosting customer spending. Thanks to personalized offers and data-driven nudges, the company has achieved a $5 increase in the average check for digital orders, contributing to strong SSS growth.

With 65.2% of all orders in Q2 coming from digital channels, Wingstop is effectively a digital brand. The company's goal is to digitize every transaction in the future, which will further boost its unit economics through the power of data. They have already built a database of over 35 million users, up from 28 million in Q1, an impressive accomplishment given that they don’t have a loyalty program. The company analyzes over 500 user parameters to create tailored offers and personalized marketing strategies, ultimately boosting spending over time. Currently, they are investing $50 million in building a proprietary tech stack to boost their data-driven capabilities.

Even without this proprietary tech product, Wingstop has been very successful in deepening customer relationships over time. As you can see below, Average Unit Volume (AUV) has consistently increased year after year, and the ceiling is still not clear. In the latest quarter, the domestic AUV reached a new high of $1.7 million, up from $1.6 million in the same period a year ago.

The company aims to achieve an AUV of $2 million, a realistic goal. In fact, UK restaurants have already surpassed this figure, meaning that it's an achievable goal for all of the company's restaurants.

In Q2, Wingstop achieved a significant milestone by opening its 2,000th restaurant, but the growth phase is far from over. During the quarter, the company raised its development outlook for the year from 240 to a range of 240 to 250 net new units, translating to a record number of net new units in a year. Wingstop estimates that it has the potential to open over 7,000 restaurants globally, and the robust development pipeline suggests that this goal is attainable.

Continued Rapid Growth & Record Profitability  

Q2 was another strong quarter of SSS and unit growth. Domestic SSS growth reached 16.8% during the quarter, largely driven by transaction growth. This positive trend shows that Wingstop customers are consistently increasing their spending.

The company expects the increasing digitization of transactions as well as menu innovation to result in strong SSS growth for the foreseeable future. This is why in Q2 it raised its full-year SSS growth outlook to a range of 10% to 12%, up from the high-single digits expected in previous guidance. The successful introduction of the chicken sandwich in 12 different flavors has significantly contributed to this optimistic outlook.

This new product not only increases order frequency but also unlocks a new growth avenue for the company. This is because WING can capture market share in a 2.8 billion annual chicken sandwich market in the US. Also, it presents an opportunity for the company to capture more occasions beyond the indulgent wing occasion. On top of that, the chicken sandwich successfully attracts top-of-funnel traffic. As management said on the recent call, this product creates a halo effect on the rest of the business as this product serves as an entry point for new guests, guiding them through the rest of the menu. Most of the time, these first-time guests become regulars, highlighting the importance of the chicken sandwich in the overall growth strategy.

System-wide sales increased 27.8% y/y to $809 million in Q2, driven by robust SSS growth and a 10% increase in total restaurant count. Wingstop's revenue also rose 27.9% y/y to $107.9 million, driven by a solid 33% increase in royalty fees and a 21% increase in sales across the 297 company-owned restaurants.

The company benefitted from a decrease in chicken wing prices over the past year, and as a result, the gross margin of its own restaurants increased to 26.3% in Q2 from 20.5% a year ago. While the company is not immune to wing price fluctuations, its increasingly diversified menu is reducing its sensitivity to bone-in wing prices. For instance, the introduction of the chicken sandwich will boost the share of less price-volatile boneless wings.

In general, Wingstop's asset-light business model and simple operations make the company very profitable. In Q2, it generated an adjusted profit of $34.3 million, excluding non-operating expenses such as income taxes, interest expenses, and non-cash expenses like stock-based compensation. This translates to an adjusted profit margin of 32%, up from 27.8% a year ago. These margins don’t compare to those of traditional restaurant chains. Just think that Chipotle, one of the most well-managed restaurant companies on the market, reported a Q2 adjusted income margin of 13% recently. This difference is due to the fact that Chipotle directly owns all its restaurants.

What Else

Wingstop has consistently traded at premium PE multiples due to its software-like profit margins. At current prices of around $165 per share, it trades at a PE ratio of 79, which is an expensive multiple, but it’s justified by the company's strong growth and profitability. While Wingstop doesn’t provide EPS guidance, analysts are projecting an EPS of $2.18 for 2023. If the PE ratio rises to 85x by the year-end due to continued solid execution, $WING can rise 12.3% from current prices to $185.

What Else

Winsgtop's recent selloff has created a great buying opportunity. This unique tech/restaurant name boasts software-like profit metrics and top-notch unit economics. It has delivered stronger SSS growth than any other restaurant brand and continues to grow SSS faster than most other publicly-listed restaurant chains. Its unique structure and its strong growth prospects make it a good buy on the current weakness.

WINGSTOP RATING

Short Term: BuyLong Term: Buy

🎯 Year-End Price Target: $191 ➡️ $185

I'm long WING.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.