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Summary

  • Another Hyped IPO Based On A Large "Total Addressable Market".
  • Fast-Casual Restaurant Segment Is Getting Crowded.
  • Wait For Better Entry Opportunities.

Zoe's Kitchen (NYSE:ZOES) made its public debut on Friday, April 11. Shares of the fast casual restaurant chain rose by 64.8% on their opening day. While momentum stocks had a tough month, investors were eager to participate in this public offering, with shares doubling in comparison to the initial pricing range.

For now the company has a lot to prove in a crowded fast-casual restaurant industry segment with valuations based on aggressive growth extrapolated far into the future.

The Public Offering

Zoe's Kitchen is a fast growing restaurant chain. The company focuses on delivering "goodness" to its customers by offering simple, fresh and tasty Mediterranean cuisine, accompanied with Southern hospitality.

The company sold 5.8 million shares for $15 apiece, raising $87.5 million in the process. Earlier, Zoe's and its bankers set an initial price range of $11-$13 per share. This range was upped in the days ahead of the offering to $13-$15 per share after which the final offering price was set at the high end of the range.

Some 31% of the total shares outstanding were offered in the public offering. At Monday's closing price of $25.10 per share, the firm is valued at $462 million. While the offering size has been relatively large, the lack of insider selling is a positive point in this offering.

The major banks that brought the company public were Jefferies, Piper Jaffray, Baird, William Blair, Stephens and Stifel.

Valuation

Zoe's Kitchen operates in the so-called fast casual segment of the restaurant industry, which is one of the fastest growing segments within the business. Research firm Technomic projects a compounded annual growth rate of 10% for the segment, implying that the market segment could grow to $50 billion by 2017. Besides simply offering meals to consumers on the spot, Zoe's has a sizable catering business, making up a sixth of total revenues.

Within the segment, Zoe's is the largest restaurant chain focusing on Mediterranean food. The company focuses on fresh, simple and tasty food. Its experienced management, attractive store economics, high comparable sales growth and projected store openings should all drive future growth, according to the company's prospectus. The company currently operates some 111 restaurants across 15 states. Note that the company already opened 9 restaurants so far in 2014, with each restaurant generating $1.47 million in revenues on average in 2013.

For the year of 2013, Zoe's Kitchen generated revenues of $116.4 million, which is up by 46.0% on the year before. Growth has been driven by store openings as well as comparable sales growth. The company did however witness a slowdown in comparable sales growth, falling from 13.4% in 2012 toward 6.9% over the past year. In the final quarter of 2013, comparable growth slowed down to 3.8%, partially due to the adverse weather conditions at the time.

On the back of higher interest payments and lack of operating income, net losses rose from just $0.3 million in 2012 toward $3.7 million over the past year.

The company operates with very moderate cash balances on a pre-IPO basis while it has $61.5 million in debt outstanding. Gross proceeds of $87.5 million resulting from the offering allow the firm to operate with a modest net cash position.

The current $462 million market valuation values the business at roughly 3.9 times annual revenues.

Investment Thesis

As noted above, the offering of Zoe's Kitchen has been a great success. The company priced the offering at $15 per share, some 25.0% above the midpoint of the preliminary offering range. Following the great opening day returns, shares are trading 109% above the midpoint of the preliminary offering range.

An investment in Zoe's Kitchen is based on the premise of future revenue as well as earnings growth. The store count of 111 restaurants in February of this year is set to double in the coming four years as the company aims to open 28 to 30 new restaurants this year. Long term management sees demand for 1,600 restaurants across the nation.

Based on these long-term restaurant number projections, and revenues north of $2 million a restaurant, annual revenues approaching $4 billion could be attainable. Given the limited market capitalization of the firm and the success of other chains like Chipotle Mexican Grill (NYSE:CMG) in particular, this is appealing for investors.

Of course these predictions assume that everything goes well. In reality, the company is breaking even on an operational level at the moment, while it will be cash flow negative for some time to come given the lack of earnings and high capital expenditures requirements. Worse, I am not impressed by the slowing comparable sales numbers. This is especially the case as the valuation is approaching half a billion and the fast-casual segment of the restaurant business is getting crowded.

One has to ask himself why you want to grow this fast if the business is failing to earn a dime on its operations. The fact that valuations are being driven by topline growth over hard earnings is one of these reasons as start-ups have met Wall Street's desire to play purely on growth.

I remain on the sidelines awaiting a nicer entry level and better operating performance.

Source: Zoe's Kitchen: Overpriced Based On Long-Term Growth And Earnings Expectations