I read a succulent bearish article on Zoe's Kitchen (NYSE:ZOES) by Seeking Alpha author Beaucage that you can read here. My goal with this article is to add to his without repeating too much. I actually have a slightly less bearish stance with a "show me" attitude so my goal is to provide you the reader with a little more and different analysis so that you can make up your own mind.
Beaucage mentioned that Zoe's is often compared to Chipotle Mexican Grill (NYSE:CMG) for its fast-casual style and has an "eerily similar" average unit size. He then declares that Zoe's same-store sales growth and average unit growth suggest it won't follow the exponential growth path of Chipotle. While I agree that is probably going to play out to be the case given the much more wide appeal of Mexican compared to Mediterranean food, it's too early to declare so just based on the numbers.
He correctly points out that average unit growth is lagging behind same-store sales growth. Barely more than half of the restaurants have been open long enough to even qualify in the same-store sales comp so this means new units are lagging behind. But let's add to that as it means two other details.
First, the company's units are growing extremely fast on a percentage basis. For example, Zoe's expects to increase its restaurant count by over 30% for this year alone. This is of course much easier for the tiny Zoe's to do with 95 restaurants at the end of last year compared to the 1,600+ restaurants of Chipotle. However, it also means the young Zoe's may need some time to build a brand image especially with new locations. The key with same-store sales, even they are outpacing new stores, is that the growth number measures how much the brand itself is building over time with returning customers and word of mouth.
We should expect new restaurants to lag behind old ones. That's even true with Chipotle. For example, in 2013 the average Chipotle did $2.17 million in sales. Despite the rapid same-store sales growth reported quarter after quarter with Chipotle, that average unit sales wasn't much higher than the $2.11 million in 2012 and $2.0 million in 2011. Apparently Chipotle experiences a similar, if not worse, new-store lag that Zoe's experiences.
All being said, the $562 million market cap for Zoe's at the time of this writing does seem excessively high any way you slice it for such a small chain. Beaucage points out that it comes to $4.7 million per restaurant, but to be fair to Zoe's it is growing at such a fast percentage clip that it is a bit unfair to only consider the restaurant count for this year. Chipotle's high valuation certainly is based more on long-term future expectations more than current store counts. Zoe's has already signed 11 new leases for next year.
In the end, while there is hope that Zoe's could be a big chain at some point and command a much higher market cap than current, it's hard to get excited about it at this time and this valuation. Adjusted EPS was $0.04 for the fiscal second quarter just reported, beating analysts by a penny, and the stock price is over $30. Unit growth and same-store sales growth is going to need a really serious kick in the behind to get quarterly and annual earnings high enough to fundamentally justify that price let alone higher. Could it happen? Absolutely, but it is likely many years away at best. For now, I'd rather be long Chipotle Mexican Grill than Zoe's Kitchen if I were forced to choose between the two, and I'm bearish on Chipotle long term (even though I wouldn't dare short it short term).
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.