Where Does Buffalo Wild Wings Go From Here?

A reader named Hayward writes:

“Chad, how about a new update on BWLD now that it exploded to the upside.”

No problem, Hayward.

Sports bar and grill chain Buffalo Wild Wings (BWLD) is a stock I have been very bullish on for a long time. Hayward is referring to my post from eight months ago entitled A Wildly Bullish Quarter for Buffalo Wild Wings. The stock has since doubled to more than $42 per share.

The investment thesis was fairly simple back in October and nothing has changed on that end. This is still a popular concept restaurant with very strong growth prospects. BWLD has more than 400 locations with a large portion of them located in Ohio, the state where it was started years ago. With a long term target of 1,000 restaurants, there is enormous expansion potential and few barriers to get there.

The stock has had a huge run as the company trounced earnings estimates, which caused me to trim the position recently as it became a large holding and traded at 30 times next year’s earnings. The stock is no longer cheap, but I still believe the stock will do well in coming years as they approach a national footprint.

I would suggest investors take some profits but still hold onto some of their stock. Since the store base can still more than double from here over the next five years, the stock should beat the market over that period, even if it isn’t cheap anymore at this point in time. Right now Peridot is holding an average sized position in the name, whereas in prior months it was a larger position due to P/E multiple expansion potential (which has since occurred).

I hope that helps, Hayward. If anyone would like to suggest possible topics for future blog posts, feel free to let me know by using the blog’s contact link at the top of the page.

Full Disclosure: Long shares of Buffalo Wild Wings at the time of writing

With Growth Stocks Seeing Multiples Compress, Investors Should Make a Shopping List

Even though the market has done well this year, It has been interesting to see so many former high flying growth stocks come back down to earth. Over the last few years there was always a group of great companies that were growing like weeds and their share prices reflected those prospects. If I think about the premier growth companies of the last five years, names such as Starbucks (SBUX), Whole Foods Markets (WFMI), Genentech (DNA), and eBay (EBAY) come to mind but there are dozens of others as well. These stocks had traded at 40 times earnings for a long time. Momentum growth managers scooped them up, but others were wary of the high P/E multiples, and that caution proved to be correct.

Not surprisingly, these stocks have underperformed as multiple compression has taken place. I even wrote about Starbucks back in late 2004, in a post entitled Sleepless in Seattle, warning investors that even if the company continued to grow, the stock might not. The coffee giant, along with the other companies mentioned above have in fact treaded water or are hitting new lows lately. At some point, though, the stocks will look attractive. Starbucks isn’t worth 40 times earnings, but maybe it is worth 20 times. Same with the other names. As former growth stars come down, investors should decide if they would like to own any of these companies, and if so, at what price. If things keep going in this direction, there might be entry points over the next year or so.

Do any of the four aforementioned companies grab my attention at current prices? After all, they now trade at between 20 and 24 times 2008 earnings projections. One jumps out at me in particular, Genentech. A 21 forward P/E seems very reasonable for a leading biotech company that can likely grow earnings 15 to 20 percent annually for the next five years. As you can see from the chart below, the stock has treaded water for two years now as the multiple compressed by more than 50%. Growth investors might want to take a look.

In general, it appears many growth stocks that were once wildly overpriced are getting more reasonable. I would suggest investors who once passed on a name or two due to valuation reexamine those companies again. Decide whether you still would like to own them or not. If so, make a shopping list complete with purchase targets and monitor them. You might find some bargains.

Full Disclosure: No positions in the companies mentioned

Sam Zell Called a Top, Will Steve Schwarzman Do the Same with Blackstone?

What does this Blackstone Group (BX) IPO mean? That seems to be a question that everyone is trying to answer. There is no doubt that monumental events, such as Blackstone Group becoming the first private equity firm to go against its own culture and issue stock to the public, deserve to be analyzed on Wall Street. That does not mean this IPO has to mark the end of something, whether it be the boom in private equity led leveraged buyouts, mergers and acquisitions, or even the overall equity market. Still, there is evidence that sometimes these game-changing events can signal something.

Consider an example. Earlier this year Sam Zell, a brilliant contrarian investor and businessman, sold his crown jewel, commercial real estate giant Equity Office Properties (EOP). The sale of EOP signaled to many that Zell thought the price he could get was so large that he had to cash out given the huge bull market for commercial real estate. There would be no other reason for Zell to sell after all these years. It appeared that the market forced his hand and he quickly moved on to Tribune (TRB), a company at the opposite end of the exuberance spectrum.

What is amazing is how well Zell timed his exit from EOP. As you can see from the chart below, the iShares U.S. Real Estate Fund (IYR), an exchange traded fund serving as a benchmark for publicly traded REITs, peaked on February 2, 2007. The index has fallen sharply (17 percent) in the five months since. Now get this, shareholders of EOP voted to approve the sale of the company on that very same day, February 2nd. And who bought EOP in a deal valued at more than $39 billion including assumed debt? Steve Schwarzman’s Blackstone Group.

Things like that (it’s not the first time this has happened) are exactly why people are trying to figure out what to gleam, if anything, from the Blackstone IPO. From my perspective, I think it says something about the global boom in M&A activity, but not necessarily the broad equity market. I think the market on the whole is tied to the economy more than anything else, of which private equity is tiny sliver. More likely, Blackstone decided to go public because they thought their firm would receive a peak valuation right now, both because PE firms are in high demand and because profit levels are through the roof due to immense deal volumes.

As we have seen in recent weeks, even a small increase in interest rates can startle investors. As soon as borrowing costs go up, it becomes much harder to issue debt to buy equity, which is exactly the mechanism that is fueling most of this private equity boom. It doesn’t matter if a 5.5% or 6.0% ten year bond rate is still pretty low in historical terms. It’s not 4.5% and therefore deals will be harder to complete. Fewer deals mean less money for the likes of Blackstone.

It will be interesting to monitor how the M&A market unfolds in the near to intermediate term. Worldwide M&A deal volume in 2006 rose 38 percent to $3.8 trillion, shattering the previous record of $3.4 trillion set in 2000. The first quarter showed year-over-year growth, so 2007 is on pace for another record. It would not be surprising, especially given the eerie coincidence of the aforementioned sale of Equity Office Properties, if we are near the peak in M&A. If that is the case, it will be yet another reason why people are so quick to postulate what something like a Blackstone IPO really means for investors.

Full Disclosure: No positions in the companies mentioned

Playing the Changes to the S&P 500

We just learned that three former highflyers are being removed from the S&P 500 index to accommodate the addition of three spin-offs from Morgan Stanley (MS) and Tyco (TYC). These changes reminded me of an article I wrote back in 2005 about the contrarian way to play these types of index modifications.

What essentially happens is that poor performing stocks are the ones that get removed from the index, in favor of better performing ones, or as is the case now, spin-offs from member companies. Contrarian investors, not surprisingly, would take the view that the very fact that a stock is being removed from an index due to poor performance would be an excellent contrarian indicator.

The piece I wrote two years ago, Examining Changes to the Dow 30 Components, focused on the Dow because that index often is changed arbitrarily even when no stock get bought out and needs to be replaced. In the case of the recently announced changes, it is simply bigger firms replacing smaller ones. Still, the three beaten down tech stocks could very well represent contrarian long ideas. If you would like to take a closer look, the trio includes ADC Telecom (ADCT) at $19.14, PMC Sierra (PMCS) at $8.14, and Sanmina (SANM) trading at $3.41 per share.

Full Disclosure: No positions in the companies mentioned

Fitch Says RadioShack Bonds are Junk, I Disagree

If you invest in junk bonds, here is an opportunity for you. How on earth Fitch determined that RadioShack (RSH) is more likely to default now than six months or a year ago is beyond me. Full disclosure: I own the stock.

From the Associated Press:

Fitch Downgrades RadioShack Ratings
Thursday June 21, 12:02 pm ET

CHICAGO (AP) — Credit-ratings agency Fitch Ratings on Thursday downgraded ratings for electronics retailer RadioShack Corp.

The company cut RadioShack’s issuer default, bank credit facility and senior unsecured notes ratings, all to “BB” from “BB+.” “BB” is the first speculative or “junk bond” rating and a plus or a minus indicates the ratings position within the category.

The rating outlook is negative. The downgrades reflect weakness in many of RadioShack’s business segments, especially its wireless products and services segment, according to Fitch.

“RadioShack has continued to report negative comparable store sales driven by weak operating trends across most of its business segments,” Fitch said in a statement. “Of ongoing concern is the increasing competition in the consumer electronics and wireless businesses from national big-box retailers and discounters as well as wireless carriers and other new wireless distribution channels.”

Why Best Buy Looks Attractive and Eddie Lampert Should Buy Circuit City

It’s rare for me to like several competitors’ stocks all at the same time. However, fears of a slowing economy, housing meltdown, and higher inflation have really hurt the consumer discretionary sector so far this year. In fact, it is one of the worst performing groups along with financial services.

Is it silly for me to praise three electronics retailers in such an environment? Some people will absolutely think so, but let me explain why I think they can all be owned. I’ve written about RadioShack (RSH) a lot since January, so I’ll spare you from reading more about them. Do a site search from the sidebar if you need a refresher.

As you may have seen, Best Buy (BBY) shares were hit hard after releasing poor results for their fiscal first quarter. Product mix was the main culprit, pushing down gross margins for the quarter, but the company expects a rebound later in the year. Best Buy also is accelerating their expansion plans in China.

Most people, myself included, believe BBY to be the creme of the crop in the consumer electronics space. Granted, that might not be saying much when you compete with RSH and Circuit City (CC), but I truly believe Best Buy’s success has a lot to do with a good management team that knows what they are doing. Personally, I love shopping there and whenever I get the urge to treat myself to some discretionary spending, it’s one of my top destinations.

What makes the stock attractive right now? Very simply, valuation. The shares are sitting near multi-year lows and look very cheap on a P/E to growth rate basis. Earnings guidance for this year was cut to $3.05 from $3.18 per share. At the current price of $44 and change, BBY trades at 14.6 times this year’s estimates. Given their leadership position in the industry, a below-market multiple, a stellar balance sheet ($5 in net cash per share to use for buybacks), and a double-digit earnings growth rate going forward, shares of Best Buy appear to be attractively priced. Assume 15% earnings growth in 2008 and a market multiple and you can justify a $56 price tag sometime next year.

The situation at Circuit City is a lot uglier. This company has been trying to find a way to get back on firm footing and stay there for a long time. Every so often they appear to be making progress but then falter and change strategies. The same thing is happening now. The stock has been cut in half over the last year, to $15 and change. Why is the stock attractive? I really don’t think it can go much lower and there are some catalysts that could push it back into the 20’s.

If the latest round of restructuring doesn’t work, I really think Circuit City will be sold. There have been interested parties in the past, but the company has resisted. Personally, I think a buyout is the best way for them to turn things around. I would love to see Eddie Lampert buy Circuit City. It looks like his kind of thing, namely a brand name and a bunch of customers, but no consistent profitability.

The stock is really cheap, one of the cheapest well-known retailers I can find. While profits are sporadic, if existent at all, the company trades for 0.2 times sales and has $2 of net cash on the balance sheet. A market cap of $2.7 billion with no leverage issues and nearly $13 billion in annual revenue is about as low as the stock can get, in my view.

If the turnaround works, the stock sees the twenties. If they finally agree to sell to someone who is willing to make dramatic moves to turn things around, the same thing happens. At $15 and change I just think the stock is pretty much near rock bottom. The risk reward is very favorable even if the company’s results have not been as of late.

So, I’m surprised to be saying this, but I think all three of these electronics retailers can be owned. If you are looking for places to reallocate some RadioShack profits, look no further than their competitors.

Full Disclosure: Long Best Buy and RadioShack at the time of writing

Home Depot’s New Stock Buyback Amounts to 30% of their Shares

There are stock buybacks and then there is the new Home Depot (HD) buyback. In case you are wondering why shares of the home improvement retailer are surging $2 this morning to more than $40 per share on news that was leaked to the market earlier this week with little movement in the stock (the company’s $10 billion sale of HD Supply), it’s because of the company’s new buyback program. Home Depot has decided to couple the $10 billion in proceeds from the sale of their wholesale business with $12 billion from a new senior note issuance to initiate a buyback of $22.5 billion. Yes, that’s not a typo, a $22.5 billion buyback.

Regardless of your view on share buybacks, there is no doubt that they are a hot concept right now. Home Depot’s market cap before today was only $75 billion, so this new buyback is truly enormous, representing 30% of the company’s outstanding shares. The company says it will complete the program as soon as is practical.

In case you are wondering how long that might take, Home Depot repurchased 174 million shares in 2006, for $6.7 billion. Given influx of cash they will be seeing shortly, it’s likely they could accelerate that pace a little bit at the very least. It seems reasonable that they could complete the buyback in three years with no trouble, and perhaps faster if they wanted to really be aggressive.

It remains to be seen what type of impact this could have on the company’s earnings. We know it will be accretive but by just how much is more of a question. Home Depot intends to update its guidance (ex HD Supply) in July. We could dig through the company’s past SEC filings to determine the impact from jettisoning HD Supply from their results, but until we hear whether expectations for the core retail business will have to be slashed yet again, we won’t really have a good idea of how much the buyback will boost the stock’s declining earnings.

Full Disclosure: No position in Home Depot at the time of writing

Calls for Semel’s Resignation Were Too Loud to Ignore

Wow, that didn’t take long did it? After the bell on Monday Yahoo (YHOO) CEO Terry Semel stepped down, paving the way for company co-founder Jerry Yang to try and get Yahoo back on track. It is unclear at this point whether Yang will hold that post long-term, or what direction the company will choose now (merge or go it alone) but one thing is clear (although not surprising), Wall Street likes the move as shown by the stock’s 8% jump after-hours yesterday. It is only up 2% this morning after the company squeezed an earnings warning into last night’s conference call. Analysts are taking their numbers down for the current quarter as a result.

Investors and analysts will now begin to throw out every conceivable merger partner for Yahoo to pursue, especially since Jerry Yang wouldn’t seem to be the best candidate for a long-term fix. The possibilities are vast, but one rumored deal is very interesting. CNBC’s David Faber reported Monday that News Corp (NWS) was considering an offer to sell MySpace.com to Yahoo in exchange for a stake in the combined company. While that is only a rumor of a potential scenario that might be discussed, a deal like that could value MySpace.com at around $10 billion and net News Corp a 25% stake in Yahoo/MySpace. That would be an unbelievable payoff for NWS after they paid less than $600 million for MySpace a few years ago. They could potentially make 16 times their money.

However, there is one issue that could prevent such a deal to even be discussed very deeply. MySpace partnered with Google (GOOG) in a long-term advertising deal last year that resulted in MySpace outsourcing the advertising management of its site to the online ad leader. Any combination with MySpace would force Yahoo to let Google run the ads on MySpace. Do you really think Yahoo would agree to that? Seems highly unlikely to me.

Full Disclosure: Long shares of Google at the time of writing

Stock Buybacks versus Dividends

There was an article written by Jennifer Openshaw last week on TheStreet.com entitled Three Reasons to Prefer Dividends Over Buybacks. A lot of people agree with that opinion, namely that dividends are cash in your pocket, which is preferable to a stock buyback. However, I’m not so sure I personally prefer a dividend payment. Let me explain why by playing devil’s advocate for the three reasons cited in Jennifer’s article.

1) “Dividends are taxed at a rate not exceeding 15% while a capital gain may be taxed at ordinary rates if the stock is sold within a year. And if you wait more than a year, who knows what the tax law will be? So the dividend, at least for now, locks in the lower rate.”

I can think of a few different scenarios and only one of them results in the dividend being the better alternative from a tax perspective. If you own the stock in a retirement plan, tax rates are irrelevant. If we are talking about a taxable account, a dividend payment triggers a taxable event, meaning you pay the 15% tax on the dividend payment in the year you receive it, regardless of whether you sold the stock or not. Buybacks don’t trigger taxes.

The argument that the tax law could change in the future, therefore you should lock in a low rate, is a poor one. Typically when capital gains rates change, they are not retroactive. If you bought a stock in 2005 and the long term capital gains tax rate goes up in 2010, you don’t get stuck paying the higher rate when you sell the stock when the law was different.

In my view, the only time dividends are more beneficial from a tax perspective is when you hold a stock in a taxable account and you sell it in less than 12 months. I would argue this occurs less often than not. Most traders don’t rely on dividend paying stocks. Long term investors are more likely to have high levels of dividend income. Also, many investors have the bulk of their investments in tax-sheltered accounts.

2) “You can’t cash in on an announcement. there is no guarantee that the buyback will happen.”

I think this argument is weaker than the first one. The article is supposedly comparing dividends to stock buybacks, not dividends to stock buyback announcements. Obviously, given the choice between a dividend payment and a buyback announcement that doesn’t happen, you would take the dividend. If you are going to compare dividends and buybacks, I think you have to simply assume you are comparing a $1 paid out to shareholders with a $1 used to repurchase shares.

A lot of buyback opponents will throw out the argument that some buybacks are announced and never implemented, but the vast majority of buybacks are actually completed, not just announced and then thrown under the rug. If you are debating which use of cash is better, I think you need to assume the announced dividends get paid and the announced buybacks are implemented.

3) “A buyback accomplishes nothing if the company is granting just as many shares on the back end for options.”

This one is simply untrue. Assume you have two companies, all else equal, except one issues 1 million options per year without a buyback program and the other company issues the same 1 million options per year but also buys back 1 million shares in the open market with available free cash flow. Did the second company accomplish anything? Absolutely!

Stock buybacks are accretive to earnings per share, regardless of whether or not the company issues options or not, simply because buying back stock is better than not buying back stock. A company’s earnings per share will always be higher if they buy back stock compared to if they don’t. How many options the company issues to employees, if any, makes no difference. Of course, the higher the repurchased share to issued options ratio, the better off investors will be.

For the most part, I don’t think the reasons to prefer dividends cited in this particular article are very compelling. If you are seeking income from your stock portfolio, clearly you would prefer dividends. Other than that, I think share buybacks in many cases are just as good as dividends. In fact, if you are a long term investor in a taxable account, I would prefer a buyback because it postpones the payment of taxes. Anytime you can postpone paying someone something, especially the federal government, the time value of money is working in your favor.

So which do you prefer? A dollar of a company’s free cash flow paid out to you or used to increase your ownership percentage of the company?

Four Reasons Why I Covered My Yahoo Short

On Wednesday I covered my Yahoo (YHOO) at $26.90 for a 16% gain. There were a few reasons for the move, but none of them was a new-found enthusiasm for what Yahoo is doing. Essentially, there are a lot of catalysts that could move the stock higher from current levels, and most of the bad news is already known. The risk-reward for Yahoo stock is no longer is attractive from the short side, in my view. Here are my four reasons for covering:

1) Trading at the Low End of a Trading Range

The stock seems to be in a trading range from the mid 20’s to mid 30’s. Business at the company has hardly been stellar, but the shares seem to have a floor around the current level. It appears things would have to get meaningfully worse from here (which is unlikely) for the shares to make meaningful new lows.

2) Terry Semel’s Potential Ouster

The firing of CEO Terry Semel would certainly give the stock a boost. I don’t have odds or a timetable for his exit, but if things don’t improve quickly, I can’t imagine he will be keeping his job for much longer.

3) The Possibility of a Buyout or Merger

Although talks with Microsoft (MSFT) broke down in the early stages, when that rumor hit Yahoo stock jumped 20% overnight. That was scary for shorts like me, obviously. I was fortunate that I didn’t cover then, when others did (a deal with Microsoft didn’t seem likely, as I wrote at the time), and the stock has come back to pre-rumor levels. However, it’s not really an experience I want to have again. While I don’t think the odds of a deal are above 50/50, liquidity and deal flow are so impressive these days, it’s hard to feel good about being short a stock that could find a dance partner if they wanted to.

4) Panama Will Show Results Eventually

Optimism from management was a little premature, but I have little doubt that Panama will show some positive results at some point. The stock rocketed above $30 the last time this was thought to be imminent, so the same thing could happen if it actually comes to fruition as management suggested months ago.

All in all, the risk-reward in the Yahoo short position below $27 per share isn’t compelling enough for me to justify keeping the trade on. As a result, I have booked my profit and will look for other opportunities.

Full Disclosure: No positions in the companies mentioned at the time of writing