First Watch trades at $19.33 and has moved in lockstep with the market. Its shares have returned 5.9% over the last six months while the S&P 500 has gained 10.4%.
Is there a buying opportunity in First Watch, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.We're swiping left on First Watch for now. Here are three reasons why we avoid FWRG and a stock we'd rather own.
Why Is First Watch Not Exciting?
Based on a nautical reference to the first work shift aboard a ship, First Watch (NASDAQ: FWRG) is a chain of breakfast and brunch restaurants whose menu is heavily-focused on eggs and griddle items such as pancakes.
1. Breakeven Free Cash Flow Limits Reinvestment Potential
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
First Watch broke even from a free cash flow perspective over the last two years, giving the company limited opportunities to return capital to shareholders.
2. Previous Growth Initiatives Haven’t Paid Off Yet
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
First Watch historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 2.2%, lower than the typical cost of capital (how much it costs to raise money) for restaurant companies.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
First Watch burned through $3.99 million of cash over the last year, and its $779.3 million of debt exceeds the $51.13 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the First Watch’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of First Watch until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
First Watch isn’t a terrible business, but it doesn’t pass our quality test. That said, the stock currently trades at 50.5× forward price-to-earnings (or $19.33 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d suggest looking at Yum! Brands, an all-weather company that owns household favorite Taco Bell.
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