Current Price – $32.99
Expected Price - <$30
Upside – 10%+
Expiration Date - Two weeks
This is a slightly different Special Situation opportunity. Yesterday WING stock jumped +13.8% in after-hours trading following the release of Q1 earnings. I believe this trading was mainly caused by algorithmic robot trading or completely superficial retail investors who misread the headline numbers for huge improvement in operational performance. In reality Q1 earnings showed hardly any positives.I expect the share price to revert at least to pre Q1 release levels ($29) in the short term.
For the full disclosure I am (and have been) short WING not only for this trade, but generally for exceedingly high valuation (50x forward PE and 25x forward adjusted EBITDA, based on the latest 2017 guidance). However, I believe yesterday's trading has opened an opportunity for a quick reversal and therefore I am highlighting specifically this short term trade for the members.
For more info on the general WING overvaluation this presentation provides some background.
Q1 earnings release
The headline numbers looked really impressive:
These are the figures that algo trading strategies (or retail crowd) picked up, digested and the started buying WING (at least that is my understanding of what happened). However, these headline number are in no way representative of how the company really performed during the quarter.
Let's starts with EPS beat - this was a pure accounting adjustment due to adoption of new accounting standard in recognition of tax benefits related to stock based compensation. From the earnings release:
The Company adopted ASU 2016-09 in the first quarter of 2017. This standard requires excess tax benefits from share based compensation to be recorded in income tax expense rather than paid in capital. The adoption resulted in a $1.7 million decrease in our first quarter provision for income taxes, or a 22.6 percentage point decrease in our first quarter effective rate, due to the recognition of excess tax benefits for options exercised in the first quarter of 2017. This positively impacted our diluted EPS by approximately 6 cents in the first quarter of 2017.
During the conference call, management clarified further:
We now record the tax benefit associated with equity-based compensation in tax expense where previously, this was recorded in equity. As a reminder this GAAP presentation change has no impact to cash flows or the amount of taxes we ultimately end up paying.
Thus this $0.06 EPS beat is nothing more than an accounting entry. Excluding this impact EPS has remained in line with expectations and increased only 10% YoY.
When it comes to revenue beat, it was driven by $3.1m one time vendor rebate recognized as revenue during the quarter.
Additionally, other revenue increased $3.1 million, primarily due to a one-time payment, based on system-wide volumes purchased in the prior year, received in conjunction with a new vendor agreement that was executed during the thirteen weeks ended April 1, 2017.
The bottom line is that the headline numbers are in no way representative on the true economics performance of the company during the quarter. This is further supported by the fact that guidance for 2017 has remained unchanged from the one issued with Q4 2016 earnings (same SSS, same EBITDA). However, after Q4 earnings shares traded down to $25-$26 vs $33 currently, even-though WING prospects have not improved in the meantime.
So how did the company actually perform during the quarter? I think the key item is that WING reported its first ever decline in same store sales of -1.1%, which was worse than its main competitor Buffalo Wild Wings (+0.5% in SSS). Industry wide headwinds continue to negatively affect the business and high wing commodity prices and labor cost increases continue to put pressure on the margins. The only positive announcement during the quarter was that SSS in March/April have turned somewhat positive although this was influenced by shifting Easter holidays.
Clearly there was nothing in the quarter that would warrant +14% share price increase after announcement or even larger +27% since the results of Q4 2016.
- This trade is based on expectation that yesterday's after-hours share price increase was driven by automatic algo buying based on headline numbers only and that reversion will occur when real numbers are looked at (might take a few days). If the reasons for yesterday's price jump are different, the price correction might not happen.
- Wingstop is a heavily shorted stock with 25% of the outstanding shares short and therefore there is a risk of short squeeze. Although I do not see how the market could get even more positive.
- Wingstop has remained overvalued for a long time despite the fact that previous PE sponsor has exited the position fully in a number of rushed secondaries and that SSS continued multi-year declines. So it can easily remain overvalued at $33/share as well.