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Summary

  • Low market penetration with 111 locations and plans for 1600 restaurants.
  • Similar strong restaurant IPOs from Potbelly and Noodles.
  • Paying off debt with offering, which will help minimize net losses.
  • Experienced management team with veteran restaurant experience and history of selling entire chains for maximum value.

The fast casual segment in the restaurant industry continues to be a huge opportunity. Led by chains like Chipotle Mexican Grill (NYSE:CMG), patrons are able to get fresh made food fast and at price points under $10 per person. According to Technomic, the fast casual market made $31 billion in 2012 and is on pace to grow to $50 billion by 2017. Investors will soon have the opportunity to invest in one of the growing companies in the fast casual sector, Zoe's Kitchen (NYSE:ZOES).

Zoe's Kitchen, a Texas based fast casual chain, is bringing an $80.5 million IPO (S-1) to the public market. Founded in 1995, Zoe's brings Mediterranean food in a fast casual atmosphere.

Zoe's Kitchen had 111 restaurants as of February 24th. At the end of 2013, the company had 102 locations, with 94 of these locations company owned and 8 franchised. Zoe's opened 27 locations in 2013 and plans to open 28 to 30 locations in 2014. Here is a look at the company's current base of restaurants:

· Alabama (14), Arizona (3), Florida (5), Georgia (13), Kentucky (3), Louisiana (5), Maryland (3), New Jersey (1), North Carolina (11), Oklahoma (3), Pennsylvania (3), South Carolina (7), Tennessee (4), Texas (29), Virginia (7)

Obviously, investors will see that the company has a strong presence in Texas. This presents a possible risk, as the company is reliant on a strong economy in Texas. The presence of 29 stores in Texas and a double digit count in two other states also shows that Zoe's can get to its long term goal of 1600 restaurants. Consider that Zoe's has also not had to close or relocate a single location since 2008, showing its restaurants have been well received by customers. In 2013, Zoe's said its expansion would center around Oklahoma and Pennsylvania with the focus being the Sun Belt states.

Company strengths:

  • Our food: Simple. Tasty. Fresh!
  • Differentiated fast casual lifestyle brand with a desirable and loyal customer base.
  • Delivering a contemporary Mediterranean experience with southern hospitality.
  • Diverse revenue mix provides multiple levels for growth.
  • Attractive unit economic model with proven portability.
  • Experienced management teams.

Growth strategy:

  • Grow our restaurant base: "We believe we are in the early stages of our growth story and estimate a long-term restaurant potential in the United States in excess of 1600 locations."
  • Increase comparable restaurant sales.
  • Improve margins and leverage infrastructure.

Here is a look at financials for Zoe's Kitchen:

# of Restaurants

Same Store Sales Growth

2008

21

+6.5%

2009

31

-2.5%

2010

43

+11.9%

2011

57

+11.8%

2012

75

+13.4%

2013

102

+6.9%

2011

2012

2013

Restaurant Revenue

$49.2 million

$79.0 million

$115.7 million

Franchise Revenue

$1.0 million

$0.8 million

$0.6 million

Total Revenue

$50.2 million

$79.7 million

$116.4 million

Net Loss

-$27,000

-$253,000

-$3.7 million

Zoe's Kitchen had a strong split between lunch (60%) and dinner (40%) sales in 2013. The company also saw catering make up 17% of total 2013 sales. Chipotle, a fast casual rival, recently expanded its catering efforts nationwide. Zoe's has a huge opportunity in catering, but also faces growing competition.

Zoe's is owned by Brentwood Associates, a private equity company. Brentwood bought a stake in Zoe's in 2007, when the chain had only 19 locations. One important thing for investors to focus on is the seasoned management with Zoe's Kitchen. Greg Dollarhyde was an early investor in Zoe's Kitchen. Dollarhyde is CEO of Pacific Island Restaurants, a franchisor that has 93 total Taco Bell and Pizza Hut locations. Dollarhyde has helped bring Yum! Brand (NYSE:YUM) franchised restaurants to Hawaii, Guam and Saipan. Dollarhyde was also the CEO of Fresh Enterprises, the holding company of Baja Fresh. Dollarhyde helped sell Baja Fresh to Wendy's (NASDAQ:WEN) in 2002 for $275 million.

Another key figure behind Zoe's Kitchen is vice president of development Allyn Taylor. Since October 2011, Taylor has helped decide on locations of new restaurants and is part of the reason no locations have been closed or relocated since 2008. Prior to joining Zoe's Kitchen, Taylor was the manager of real estate for Panera (NASDAQ:PNRA) and a vice president of real estate for P.F. Chang's (NASDAQ:PFCB) and Pei Wei. Taylor brings a vast knowledge of site selection that will benefit Zoe's Kitchen and its shareholders going forward.

Zoe's Kitchen has not announced details of its share price range yet. The company has tentatively planned on raising $80.5 million, but that range could go up based on demand. Zoe's will use the proceeds from the IPO for three main purposes:

  • Repay entire amount of outstanding borrowings;
  • Support growth, open new restaurants;
  • Working capital.

This is good use of proceeds in my opinion. The company should aggressively continue its expansion by focusing on one state or region at a time and growing through existing stores. The company's planned 25 to 30 stores opening per year is fairly conservative and could rise in 2015 after a successful IPO. Paying debt is also the right step here as the company has reported net losses recently. Trimming interest payments will help the company bring more money to the bottom line as they grow total restaurant sales through an increase in the number of restaurants and same store sales growth.

To me, this IPO is similar to both Noodles (NASDAQ:NDLS) and Potbelly (NASDAQ:PBPB). Both of these IPOs offered investors national growth for regional chains. At the time of Noodles IPO, the company had 339 locations and a goal of hitting 2500 in 15 to 20 years. The company had doubled the number of locations in the last six years and seen same store sales rise 5.4% in the most recent year. Potbelly had 286 locations in 18 states when it filed its S1.

Both of these IPOs saw strong demand, which saw shares have nice gains on their opening day. However, both stocks are also down since that time. Noodles shares are up a meager 5% since their IPO after seeing shares shoot up over the first month. Potbelly shares are actually down 39% since their IPO. Another thing to keep in mind is there are several large restaurant companies like Darden (NYSE:DRI), Buffalo Wild Wings (NASDAQ:BWLD), and Dunkin' Brands (NASDAQ:DNKN) who are all looking at new growing brands to acquire. Zoe's Kitchen could be worth a look for any of these companies with its relatively small restaurant count and presence in the key growing fast casual market.

Investors should watch the pricing on Zoe's Kitchen shares before their IPO. The recent decline may cause limited investor demand, which could provide a great entry point to invest in Zoe's Kitchen. Likewise, high demand and a strong IPO of Zoe's could cause shares of Noodles and Potbelly to see some forward momentum. I believe with a lower store count and a place in the fast casual sweet spot, Zoe's shares are the better investment going forward, depending on IPO pricing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Full disclosure that I work for a restaurant company in a state Zoe’s Kitchen does not operate in. However, with Zoe’s national expansion, I would work for a direct competitor in a similar style of food once Zoe's exists in my state.