Wingstop

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Wingstop Inc. is a rapidly growing restaurant franchisor and operator specializing in cooked-to-order chicken wings and seasoned fries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Wingstop operates with a high degree of franchising (almost all restaurants are franchised), resulting in a capital-light business model with a focus on generating royalty revenue from franchisees. This approach enables it to expand faster with less capital investment than if it operated all of the stores.

Business Overview

Wingstop is a fast-casual restaurant chain that focuses on cooked-to-order chicken wings. They’ve been growing consistently over the past years.

  • Revenue Distribution:
    • Wingstop generates revenue primarily through two streams: franchise fees and royalties from franchised restaurants, as well as sales from company-owned restaurants.
    • A significant portion of its revenue is derived from advertising fees and supply purchases by franchisees, highlighting their reliance on the franchise model.
    • International expansion, though smaller, is becoming a more significant part of the revenue mix, especially with the rapid expansion in Asia and Europe.
  • Industry Trends:
    • The restaurant industry is known for intense competition and is always changing with new trends and customer preferences. This is particularly visible in the quick-service segment where Wingstop competes, as there are many alternatives for consumers.
    • There’s an ongoing trend for digitalization in the quick-service sector. This involves delivery platforms, ordering, and loyalty programs.
    • Companies are being increasingly forced to focus on cost management and to address rising commodity and labor expenses as consumers become increasingly price-sensitive due to inflation concerns.
  • Competitive Landscape:
    • The competitive landscape includes national fast-food chains and smaller, specialized chains.
    • Competition is intense, but only a few competitors offer chicken wings as the main product. Wingstop’s competitors include both established brands and rising new entrants.
  • What Makes Wingstop Different?
    • Franchise Focus: Its franchise-heavy business model is a great distinguishing factor. With very limited company-owned restaurants, the company limits its capital expenditure, while receiving recurring royalty income, advertising fees, and sales from franchisees.
    • Specialized Menu: Wingstop’s narrow menu focus of chicken wings is an important element of its competitive advantage.
    • Digital and Delivery: Wingstop has aggressively expanded its digital platforms and delivery options, which have become critical growth drivers. The emphasis on convenience and off-premise consumption has helped them to adapt to changing customer preferences and to reach a wider customer base.

Moat Analysis

Wingstop has a narrow moat that comes from its combination of brand, network, and cost advantages.

The moat isn’t particularly strong, because barriers to entry aren’t exceptionally high in the restaurant industry and switching costs are mostly negligible. This means that they are vulnerable to strong competitors.

  • Brand: Wingstop’s brand recognition, while not at the same level as some larger fast-food chains, generates customer loyalty and has been built over the years via constant advertising and marketing strategies. The brand has a certain level of recognition due to its differentiated taste and cooking methods, which helps create a slight premium that customers will often pay. The brand continues to invest in marketing and menu innovation to keep customer interest in their food.
  • Network: Though they have limited physical restaurants of their own, their vast and growing franchisee network with 2,000+ locations generates substantial brand recognition and ensures that Wingstop’s locations are readily available across the world. Their digital ecosystem and delivery options make them very easily accessible even without the location nearby.
  • Cost advantages: While not the primary source of its moat, the company has been able to utilize franchising to maintain a very lean organizational structure, with high returns on invested capital (ROIC).

Moat Rating: 3 / 5

Wingstop has a narrow moat rating due to its combination of brand, network, and some cost advantages. However, its competitive advantages are not that strong because switching costs are quite low and there’s always the possibility of competition gaining market share through new innovative concepts and better pricing.

Risks

Wingstop faces a number of risks that could potentially harm its moat and future profitability:

  • Commodity Costs: Increases in chicken prices could compress profit margins, forcing the company to either raise prices or accept lower profits. Since Wingstop operates in a very price-sensitive fast-food industry, they might not be able to pass on all the increase in costs to the customer, which can lead to decreased profitability.
  • Competition: Competition from other quick-service restaurants, both national and local, is high. With more companies trying to enter the fast-casual, chicken, and delivery market, this will intensify the pressure on them to keep up with the new trends.
  • Macroeconomic Factors: Economic downturns might affect consumer spending habits, which would directly influence the revenue of the company. Customers may choose to forgo dining out or shift to cheaper alternatives.
  • Franchisee Problems: While franchisees help the company grow its business, a portion of them are independent and, may not always abide by the company standards or follow guidelines, thereby affecting the customer experience and the brand itself.
  • Management Missteps: Incorrect strategic decisions by the leadership (such as focusing on the wrong growth initiatives or failing to adapt to consumer trends) could erode their economic moats.
  • Technological Disruption: Rapid changes in technology may put their platforms or operations behind others, making them less attractive to the customers. This risk can be considered to be medium to high for the company, considering that many of their customers prefer to use a digital platform for placing orders and want to get fast delivery.
  • Supply chain issues: As a restaurant chain, supply chain risks are always present. However, the impact was especially seen in recent history when some companies have faced increased prices or delivery issues related to shortages or logistical problems.

Business Resilience

Wingstop has been shown to possess strong resilience due to these factors:

  • Adaptability: Wingstop has proven its adaptability in shifting to a digital-first and delivery-oriented business model. By focusing heavily on technology and streamlining their process, the company has been able to withstand the shift in demand.
  • Brand Loyalty: While consumers will always jump to alternatives that are cheaper, the brand loyalty does help them maintain a loyal base of returning customers, which provides an element of stability.
  • Franchising Model: The franchised nature of the business model gives them a bit more flexibility in facing adverse conditions, as the franchisees, not the parent company, are the main ones to face the economic downturns.
  • Management Experience: With experienced managers at the helm of the company, who have managed the company through tough times, they have shown the capability to maneuver the company through challenges.

Financial Analysis

Wingstop’s financial performance reflects a growing business that is benefiting from its franchise model.

  • Recent Revenue Growth: Revenue increased year-over-year in the recent quarter of 2024, which was largely driven by a high same-store-sales growth and new restaurants.
  • High Profitability: With nearly no company owned restaurants, most of the costs are borne by franchisees. This means that a much larger proportion of revenues translate into operating income. In turn, this drives high profitability for the company, showing in their consistently high earnings.
  • Capital Light Business: Since most of the revenue is generated from a franchise and royalty model, capital expenditure is lower as they do not require to build or operate most of the restaurants themselves. This means that profits can go directly to the company shareholders, or for further expansion of operations.
  • Share Buybacks: The management have also aggressively used the high profitability to buyback their shares. This can help in providing higher long term returns to shareholders, but at the same time, might raise questions if the cash was being spent better in operations and other improvements.
  • Debt Management: The company uses a combination of debt and equity for funding. They have an interesting strategy of using debt financing to buy back shares, which can be seen as a positive when the cost of capital is low, but poses risks in terms of increased leverage.

Understandability: 2 / 5

While the core business model of a fast-food restaurant is relatively easy to understand, the financial structures and implications of a franchise based business model are difficult to fully grasp. The company’s reliance on franchisee driven sales and royalties, and the nuances of non-standard accounting metrics make the business’s financials more complex to comprehend.

Balance Sheet Health: 3 / 5

The balance sheet is reasonably healthy with adequate current assets and manageable debt. It is not very strong due to a high leverage as a result of taking up debt to repurchase shares. Additionally, the company has increased liability to fund their supply chain purchases which makes their liability higher. However, the company also has high earnings and solid cash flow, which gives them more resilience.

Recent Concerns and Controversies

  • Guidance: The company has slightly lowered guidance for year 2024. While this isn’t necessarily a sign of bad performance, the stock price may decrease as a result of the lower forecasts.

In terms of long-term concerns for the company, they face a threat of their moats weakening with competition, technological disruption, and commodity costs increasing. Therefore investors would do well to monitor management’s strategic response to these factors.