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Wingstop (WING) caught my eye and I was impressed by its asset-light, highly-franchised business model.
The Company is primarily a franchisor, with approximately 98% of Wingstop’s restaurants currently owned and operated by independent franchisees. We believe our asset-light, highly franchised business model generates strong operating margins and requires low capital expenditures, creating stockholder value through strong and consistent free cash flow and capital-efficient growth.
Refer to Q2 2024 10Q (PDF Page 15)
While people have questioned WING’s high P/E, I had no issues with its valuations given its PEG of 2.54. Also, I was impressed by WING’s clear and concise 10Qs and 10Ks. Simple business model, high growth, what is not to like? However, I have a few questions for the management.
CAPEX
WING - CAPEX
So, what is all this CAPEX for? As per WING’s 2023 10K (PDF page 32) out of the 265 stores that were opened, only 4 were opened by the company. The company purchased two stores from franchisees. Let’s try to reconcile the numbers.
WING - Company Owned Stores
Now, how can WING have had 70% more CAPEX in fiscal 2023 when the store opening and purchase activity was higher in fiscal 2022? Interesting, right? I can tell you where the CAPEX went. I had to figure it out—technology spending.
Capitalizing Technology Spending
What does capitalizing technology spending mean? Say a company upgrades its technology infrastructure and software, there are two options:
Expense the cost as it is incurred; OR
Record it as follows:
Add it to PPE (Property Plant and Equipment) in the Balance Sheet.
Show it as CAPEX under “Investing Activities” in the Cash Flow Statement.
Over time depreciate the PPE entry. That is when it shows up in the Income Statement as a depreciation expense. Also, as it would be a depreciation expense, it would help keep future Cash from Operations elevated.
So, if WING were to expense it right away, its Net Income and Cash from Operations would be in the garbage bin. By recording this as a CAPEX, it is pushing out recording expenses over a longer period, thereby inflating its earnings and Cash from Operations.
Now, what is the correct method to be applied when it comes to WING? That is for the management, auditors, and regulators to decide. In my opinion, I am no one to pass judgment, WING should be recording it as an expense immediately. Why?
Digital sales increased to 68.3% of system-wide sales, as compared to 65.2% in the prior fiscal second quarter.
Refer to Q2 2024 10Q (PDF Page 15)
A few things stand out here:
Digital sales make up for a huge chunk of WING’s revenues.
WING has been making technology-related CAPEX every quarter for the last 6 quarters I checked.
Investing activities. Our net cash used in investing activities was $25.3 million in the twenty-six weeks ended June 29, 2024, an increase of $3.0 million from net cash used in investing activities of $22.2 million in the twenty-six weeks ended July 1, 2023. The increase in net cash used in investing activities was primarily due to an increase in capital expenditures related to our technology investments as compared to the prior fiscal year period.
Refer to Q2 2024 10Q (PDF Page 23)
Here is the interesting part; the “technology investments” wording is missing from the FY2023 10K while it is in all the three 10Qs for 2023.
Investing activities. Our net cash used in investing activities was $52.2 million in fiscal year 2023, an increase of $23.5 million, from $28.7 million in fiscal year 2022. The increase in cash used in investing activities was primarily due to an increase in purchases of property and equipment during the current fiscal year, as well as an increase in restaurant acquisition costs as compared to the prior fiscal year.
Refer 2023 10K (PDF page 38)
This can be an honest mistake or a more egregious case of “Differential Disclosure”. Which is it? I don’t know. Be that as it may, let’s now adjust WING’s Operating Income and Net Income for FY2023 and the six months ended June 2024 assuming WING should be expensing the CAPEX.
Note
WING does break out the investing activities by line item in the 10Qs and 10K. So, we know exactly how much went toward PPE versus how much went toward restaurant acquisitions.
Orca Fin’s Adjustment of WING’s EPS
So there you go. Essentially, even though WING is doing well, people may be overpaying by a whole lot more than they believe. What is scary is how the numbers start lining up from line item #5. I did a double take, one can’t make that up. What is the probability of that happening when the variables are different?
In any event, judge for yourself. However, there is one more thing.
Negative Equity and Debt
Having negative equity or shareholders’ deficit can be an issue or a nonissue. Many mega-cap names have negative equity as they have been paying out huge dividends or are essentially asset-light or doing large share buybacks. WING explains it in detail (Refer to Q2 2024 10Q - PDF Page 10). However, it can become an issue if Current Liabilities are larger than Current Assets.
A cursory look at WING’s Balance Sheet will reveal that its Current Assets are larger than its Current Liabilities. There is a catch though; WING has 713.3 million in long-term debt (adjusted for debt issuance costs, net of amortization). Now consider this statement:
As of June 29, 2024, the Company’s leverage ratio under the 2020 Class A-2 Notes and the 2022 Class A-2 Notes was less than 5.0x. Per the terms of the Company’s debt agreements, principal payments can be suspended at the borrower’s election until the repayment date, as long as the Company maintains a leverage ratio of less than 5.0x. Accordingly, the Company elected to suspend payments following the principal payment made in the second quarter of 2023, and the entire outstanding balance of $720.9 million of the 2020 Class A-2 Notes and the 2022 Class A-2 Notes has been classified as long-term debt due after fiscal year 2026.
Refer to Q2 2024 10Q - PDF Page 11
Interesting, right? Now, what if what I discussed earlier is the correct interpretation? What happens to this debt? No prizes for guessing. It gets even more interesting. What is backing this debt?
The 2020 Class A-2 Notes and 2022 Notes were issued in securitization transactions, and are guaranteed by certain limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiaries of the Company and secured by a security interest in substantially all of their assets, including certain domestic and foreign revenue-generating assets, consisting principally of franchise-related agreements, intellectual property, and vendor rebate contracts.
Refer to Q2 2024 10Q - PDF Page 11
Parting Thoughts
As I have always maintained: Everybody has the right to an opinion, however, we can agree to disagree nicely. I am not claiming that any fraud is going on here. I actually started looking at WING to do a bullish article, this ended up anything but one. However, I hope some would have learned something from how expenses can possibly be moved around.
Until next time. Have fun!!!