Buffalo Can Fly, Sometimes Too High
Few companies have been more successful than Buffalo Wild Wings (BWLD) in combining the love of sports with the urge to overeat while drinking alcohol. The firm’s winning formula pushed EPS from a split-adjusted $0.42 in 2004 to an estimated $5.09 for the current year.
Over the long haul the shares have reflected those great results, rising from a split-adjusted 2004 low of $11.40 to a recent 2014 pinnacle of $167.64. Traders seemed surprised on Wednesday when better than expected Q2 profits of $1.25 per share sent the shares down $21.98 (-13.15%).
How could a nice earnings beat translate to such bad market action? It all comes down to valuation and expectations. Even the best companies can get overpriced. A look at BWLD’s long-term data shows its median P/E has historically centered on 24x.
Over enthusiastic momentum chasers pushed the stock to almost 44 times forward earnings around mid-year 2007 when EPS were on track for $1.10. Despite great growth in 2008, 2009 and 2010 the old high was not left behind for about three and a half years.
The peak in March of 2012 came at a slightly less crazy multiple of 31x. Buyers at that year’s top had to suffer for more than a year before seeing progress on these non-dividend paying shares. A similar fate befell those who ventured into BWLD late last year at $152.50.
At more than 40x trailing earnings, excellent operating results were not enough to keep shareholder results above water, even as the broad market went on hitting new records.
Tuesday’s new all-time high of $167.64 represented a more than 37% valuation premium to BWLD’s normalized level. Clearly, expectations were too high and the stock price was ahead of itself.
Still, for true long-term thinkers, the company is as tempting as a plate of their hot wings accompanied by a few beers.
Buffalo Wild Wings has a debt-free balance sheet, no pension liabilities and no preferred shares. Value Line notes the company’s metrics rank very high in all categories except stock price stability. BWLD's slightly sub-par score in that department is actually helpful in a way I'll describe shortly.
How can you play a great company that is still a bit pricey? Consider selling some January 2016, out-of-the-money puts. The ‘if exercised’ prices will be well below the current quote plus it’s pretty likely that sales, cash flow and EPS will be substantially higher by the time expiration date rolls around.
Here is what the LEAP put prices looked like in mid-afternoon with BWLD trading @ $144.40.
If you are willing to hold your positions until expiration only one of two possibilities can occur for sellers of these options. You will either keep 100% of any premiums received or you’ll end up owning BWLD shares at net prices ranging from (based on the last option trade pricing) $109.66 to $115.95 per share.
The net exercise price for even the most aggressive (BWLD Jan. 2016, $135 put) level is below any actual trading price for BWLD since last October.
If Buffalo Wild Wings fulfills EPS expectations of $5.98 for 2015 the implied P/E on the ‘if put’ price of $109.66 would be a much more reasonable, and lower than average (for BWLD) multiple of 18.3x.
Writing options in a margin-type account requires no upfront cash outlay although it does tie up buying power, a non-cash expense. That makes it cash-flow positive starting on the next business day.
Buffett and Berkshire Hathaway (BRK.A, BRK.B) used this technique quite successfully prior to its take-over of Burlington Northern.
There can never be a guarantee that the stock in question won’t go below your entry price but, if you are willing to own the underlying stock anyway, it’s hard to get an unpalatable result.
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