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Summary

  • Zoe's comps are not telling the real story.
  • Average unit volume growth lagging comps is a bad omen.
  • The prices paid for franchisees have been plummeting.

Investors have been hankering for more of Zoe's Kitchen (NYSE:ZOES), and the company has been happy to comply, offering two rounds of stock since April 2014. The company's IPO issued 6M shares at $15. The bulk of those proceeds went to paying off the $60M in debt that the company accumulated during its store expansion. Brentwood, the company's private equity sponsor who owned 45% of the company post-IPO, was happy to accommodate investors in August by offering 3.8M of the 4.5M shares sold for $30.25.

There has been much speculation that ZOES is the next Chipotle (NYSE:CMG). The footprint of the stores is eerily similar, with ZOES averaging 2,750 square feet and CMG averaging 2,500. ZOES' boxy, bright restaurants mimic CMG's sleek modern feel. Investors seem to be hoping that swapping out Monterey Jack cheese for Feta and black beans for hummus is the recipe that ZOES needs to be the Mediterranean equivalent of CMG.

Although the Q3 revenue estimate provided by the company in its August filing was marginally better than analysts had expected ($41.7M vs. an estimate of $40.5M), it doesn't appear that ZOES will follow the exponential growth path that has blessed CMG. Growth in ZOES' average unit volume (AUV) has lagged its comp numbers significantly. See the table below to compare the two metrics:

2010

2011

2012

2013

AUV

+9.3

+7.4

+9.39

+3.45

Comps

+11.9

+11.8

+13.4

+6.9

Difference

2.6

4.4

4.01

3.45

It is important to note that although investors get very excited about comp growth, ZOES has so few stores that qualify for inclusion in its comp count that the comp numbers are really not representative of overall unit metrics. At the end of 2013, only 55 of ZOES' total 94 company-owned stores were included in the comp base.

When average unit growth is less than comp growth, this means that new stores, which are not included in the comp base, are growing at a slower rate than the older stores - which are in the comp base. This is important because the entire growth story for ZOES rests on huge unit growth followed by steady comp growth. The bulk of ZOES' stores are in the South. Roughly 26% of stores are in Texas, 13% in Georgia and 13% in Alabama. It is yet to be determined if the ZOES concept will be embraced in the rest of the country. Based on the numbers to-date, it appears that ZOES is not as successful outside of its original territory.

The reason that comp growth is so enticing to investors is that it typically provides operating leverage. More revenue spread across flat occupancy expense provides great margin growth. ZOES does not break out occupancy costs as a separate line, but includes them in store operating expenses. For the year ended 2013, ZOES' store operating expenses were 18.8% of restaurant revenue vs. 18.5% in 2012, negative leverage despite positive comps. Although operating expenses showed a miniscule amount of leverage in the first six months of 2014 (18.97% of restaurant revenue vs. 19% in the previous period), it is unclear if comp growth will be enough to expand margins enough to make a difference in the bottom line.

I would tread lightly before buying ZOES stock. With a current market cap of $570M, investors are valuing ZOES at $4.7M per unit. As a comparison, ZOES most recently paid $600k each for two franchise units that were purchased in January 2014. Even more interesting is the fact that the price paid to purchase franchise units has been dropping steadily. In 2011, ZOES paid as much as $2.6M per unit when buying franchise units - 4x the current price! Obviously, there is always a huge spread between private and public valuations, but the downward spiral in the company's own valuation of franchisees might be an indication of cracks in the ZOES growth story.

Source: Zoe's Kitchen Comps Not Telling The Whole Story - Slower Growth At New Stores