I ran across a very well organized, written, and compelling Seeking Alpha piece written by Suhail Capital on El Pollo Loco (NASDAQ:LOCO) entitled El Pollo Loco: PE 'Bust-Out', 20+ Years Of Failed Domestic Expansion, Pre-IPO Window Dressing Make An Ideal Short. While I have no position in El Pollo Loco currently, I have it on watch for a possible entry on the long side. And while I was originally by the details regarding the historical failed attempts to expand the chain east of the Rockies, I think it's too soon to count El Pollo Loco out for round 2. My goal with this article is to be a bit of a devil's advocate while providing some positive balance to Suhail Capital's excellent negative piece.
Image source: Houston Chronicle
First, Chipotle Mexican Grill (NYSE:CMG)
While I agree with the author that El Pollo Loco is no Chipotle Mexican Grill, at least not right now, that doesn't mean it won't ever be in terms of numbers and it isn't necessarily even that far off now. Consider this. In 2013, the average Chipotle in the U.S. did $2.169 million in sales while the average El Pollo Loco did only $1.5 million.
That 45% favor for Chipotle over El Pollo Loco doesn't tell the entire tale. The average check per person last year was around $9 at Chipotle and around $5.83 at El Pollo Loco. This is a 54% higher average check yet only 45% higher per store sales. In other words, El Pollo Loco actually generates more guest traffic than Chipotle does on a per restaurant average. The author frequently criticizes El Pollo Loco for its same-store sales growth being so dependent on an increase in average check, but the reality is for El Pollo Loco, using the Chipotle benchmark, the guest traffic is fine - arguably more than fine - it's the average guest check that needs to go up. And El Pollo Loco doing exactly that and doing it well.
Second, failed expansion in the past were during different times
The author lists 10 states entered and exited from 2005 to 2012, with most of the restaurants closing in 2010 and 2011 which was over 3 years ago. He fails to mention that there is one state currently not following the old trend and that is the state of Texas with 8 locations. In fact, he failed to make mention of Texas at all. Evidence suggests Texas has vast untapped potential.
In Houston alone, for example, the company has "identified an initial 80 trade areas for potential restaurant development by us or our franchisees over the next several years, and we believe there are additional development opportunities beyond this."
Those 80 in just one Texas city represent 25% of the number in the entire state of California where 88% of its locations currently are. Even if El Pollo Loco finds it tough to expand outside of its existing states, these figures suggest an opportunity for multiples of chain growth possible in Texas alone.
Image source: El Pollo Loco filing
As for other states, as the author points out, the company has drastically changed it menu and the marketing that goes with it and caused a dramatic spike in average guest check contributing to same-store sales. Had these failed regions had the new El Pollo Loco with its new menu, new marketing, and new average guest check perhaps things would have been different. El Pollo Loco has since witnessed 11 quarters in a row of positive same-store sales gains sometimes sizable.
Image source: El Pollo Loco filing
Ever hear of a turnaround or a comeback? If El Pollo Loco is successfully executing one, it seems unfair to judge its future expansion plans by its inferior past. Additionally, according to the company, there have been several positive changes in the industry when compared to three years ago for which El Pollo Loco is currently seeing increasing benefits. In its filings it says (my emphasis added),
"We believe we are also well positioned to benefit from a number of culinary and demographic trends in the United States. We expect that the trend towards healthier eating will attract and increase consumer demand for fresh and hand-prepared dishes, leading to a positive impact on our sales. Furthermore, as indicated by recent high growth in the Mexican restaurant segment, we expect to benefit from increased acceptance of Mexican food in the United States in the general market. Finally, we also anticipate benefits from the continued growth of the Hispanic population in the United States, which, according to the U.S. Census Bureau, has grown from 50.5 million people in 2009 to 53.0 million people in 2012, and is projected to reach 78.7 million in 2030. The growth of the Hispanic population is expected to outpace overall population growth, and the Hispanic population as a percentage of the total U.S. population is expected to increase from 16.3% in 2011 to 21.9% by 2030."
Apparently in quick-service or fast-casual Mexican food market, things can change and change very quickly. This is in-line with Chipotle Mexican Grill's second quarter conference call. During it, co-CEO Monty Moran stated,
"If you look at some of the markets that we used to call developing markets and in fact the markets that we even thought were failing markets to be quite honest like California some years ago, California went from a developing market to a never mind we won't build in California market and then overnight became a proven market and now is the state in which we have more stores than any others -- far more stores than any other state and it kind of feels like shooting fish in a barrel. We seem not to be able to miss in California."
Regions change. Trends change. If the big bad Chipotle Mexican Grill saw itself "overnight became a proven" success in California, who is to say El Pollo Loco won't experience similar now in areas it struggled with years ago just as Chipotle Mexican Grill struggled in California?
On a personal anecdotal note, El Pollo Loco used to be a place I would drop by for a quick couple of pieces of grilled chicken at a buck a piece. What a deal! I always used to see it as more of a snack stop rather than a place to get a meal. Clearly you can see it in the numbers and you can see it in the new menus and marketing in Suhail Capital's piece: El Pollo Loco is becoming more of a place to get a full meal rather than just a tiny bite to eat. That's a great change that seems to be working wonders as it got rid of its dollar menu and pushes full meals more.
The jury is still out either way and, as such, I would say El Pollo Loco is a far cry from "an ideal short." I'd even say the unknowns at this stage make it more risky than Chipotle to short, and I consider Chipotle a dangerous short in the near term. Suhail Capital wrote a great piece, filled with great information and great analysis. His conclusion may very well prove to be right. However, El Pollo Loco's recent history and changes and potential opportunity have me watching from the sidelines to potentially go long rather than short. Many of the criticisms, such as increasing guest check size along with little foothold east of the Rockies, I actually see as a potential positive that could lead to great location growth in the years ahead.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.