Even during a down period for the markets, First Watch has gone against the grain, climbing to $17.34. Its shares have yielded a 23.9% return over the last six months, beating the S&P 500 by 33.7%. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy First Watch, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.
We’re glad investors have benefited from the price increase, but we don't have much confidence in First Watch. Here are three reasons why FWRG doesn't excite us 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
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
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 Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared 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 2.1%, 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 $12.28 million of cash over the last year, and its $809.7 million of debt exceeds the $33.31 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 isn’t one of our picks. With its shares topping the market in recent months, the stock trades at 42.5× forward price-to-earnings (or $17.34 per share). This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere. We’d suggest looking at one of our all-time favorite software stocks.
Stocks We Like More Than First Watch
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