Zoe's Kitchen - Caution Ahead As The Company Still Has A Lot To Prove

Aug.30.14 | About: Zoe's Kitchen (ZOES)

Summary

Zoe's Kitchen reports second quarter results more or less in line with consensus estimates.

The full year outlook is not so inspiring, as the current pace of comparable store sales growth is not sustainable for the rest of the year.

The valuation is too steep for me despite growth prospects amidst poor current margins, capital expenditure requirements and a competitive playing field.

Investors in Zoe's Kitchen (ZOES) hardly reacted to the company's second quarter results which slightly topped the preliminary results which the company reported earlier in August.

While the company demonstrates modest earnings, a steady and impressive comparable store sales growth pace and continues to open new stores, I think the company has a lot more to demonstrate in order to justify its current valuation.

As such I remain very cautious, not seeing any appeal yet as the company continues to attach a rich valuation at over half a billion to the emerging restaurant business.

Solid Quarter

Zoe's reported second quarter revenues of $41.9 million, a 54.1% increase compared to the year before. Earlier in August, Zoe's pre-release the earnings results, looking for sales of $41.6-$41.8 million.

On the bottom line, the business reported earnings of $1.1 million which is a significant increase from the reported earnings of $0.4 million last year. On a per share basis, earnings doubled to $0.06 per share.

The reported operating earnings came in at the high end of the preliminary guidance for earnings of $1.4-$1.6 million as well.

A Look At The Strong Growth

Before I start this discussion, it is important to realize that the second quarter contained just twelve weeks. As such the numbers on a sequential basis look rather weak, while in fact they are not.

Overall revenues rose by more than 54% thanks to restaurant openings, as the business opened 7 new stores over the past quarter. Yet comparable restaurant sales growth of 7.5% was rather healthy as well. For the entire year the company aims to open 29-30 stores, with 11 leases already signed for next year.

The 7.5% comparable sales growth was quite solid driven by healthy developments across the board. Traffic was up by 2.8%, prices rose by 2.0% and a favorable mix added another 2.7% in sales.

Comparable sales growth and growing operating in general boosted restaurant contribution margins by 70 basis points to 21.2% of sales. Note that while the net earnings improvement was substantial, adjusted earnings came in at $0.8 million which compares to $0.6 million as reported last year.

GAAP earnings were aided by a $0.1 million tax benefit instead of an expected provision given the positive underlying operating earnings.

An Update For The Year

Based on the performance so far, Zoe's anticipates annual sales of $167.5 to $170.5 million based on comparable restaurant sales growth of 5 to 6% and 29-30 restaurant openings.

The company anticipates restaurant contribution margins of 20.5-21%, but failed to provide a specific earnings per share target for the entire year.

Valuation

At the end of the quarter, Zoe's held $42.8 million in cash and equivalents, while the debt position of $20.6 million results in a comfortable net cash position of about $22 million.

At the moment, Zoe's has about 19.5 million shares outstanding which at $30 per share values equity at around $585 million, and operating assets at $560 million.

This values the company's operations at about 3.3 times annual sales which is not even that high. Given the lack of any real earnings at the moment earnings multiples are useless in valuing the business.

Implications For (Potential) Investors

Back in April, I last had a look at the prospects for the company following the public offering which took place at $15 per share. Like many IPO's this year shares witnessed an impressive jump on their opening day.

At the time I found that shares have been overpriced with the vast majority of the valuation being based on future growth, anticipated earnings improvements and key words like a large addressable markets. This is as investors are hoping that the company can become the next Chipotle Mexican Grill (NYSE:CMG). For the long run management at the time anticipated a potential store base of 1,600 locations.

At the time I was not convinced about the valuation given the lack of earnings, the slower comparable store sales growth numbers and an ever crowded fast-casual food business. While I must admit that comparable sales accelerated quite nicely for the past quarter, and that the company is posting modest earnings on its operations, the current size of the operations remains very small.

Despite the planned growth, Zoe's has yet to report real earnings on its sales. Despite the solid comparable sales growth, the growth is not that impressive for such a young chain and low age of its stores with many of them not being open for a long time yet.

As a result I continue to be very cautious on the prospects for the business, watching the action from the sidelines with a slightly bearish stance.

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.