El Pollo Loco is valued at more than 5 times Popeyes on a per-restaurant basis.
Popeyes is growing its units much faster. El Pollo Loco doesn’t deserve its super-premium multiple.
Investors are setting themselves up for major disappointment in the quarters and years ahead.
At the risk of over simplifying just how overvalued El Pollo Loco (NASDAQ:LOCO) appears at this time, take a look at Popeyes Louisiana Kitchen (NASDAQ:PLKI) for comparison. Popeyes has a market cap just under $1 billion and El Pollo Loco has a market cap just over $1 billion so it does make it a bit easier to stack them up against each other not to mention they are both the quick-service chicken industry.
Despite both having similar market caps, Popeyes owned at the end of 2013 over 2,200 restaurants while El Pollo Loco owned just over 400 restaurants. The average Popeyes did $1.3 million in sales while the average El Pollo Loco did $1.5 million, not a monster difference but credit to El Pollo Loco on that.
Both chains are concentrated mostly in a few states. El Pollo Loco has the vast majority of its locations in California while Popeyes is more spread out but has 70% of its locations in 10 states. Points to both in terms of potential: if the brand grows in popularity beyond their current regions then the market is possibility still wide open. I'll give Popeyes more credit though in that it has already proven for sure it's not just a 1 or 2 state wonder and the average restaurant handily beats Yum! Brands' (NYSE:YUM) KFC sales in the United States of just $0.9 million average last year.
Next you have unit growth plans. Popeyes is targeting annual unit growth of between 4% and 6% over the next five years. For El Pollo Loco, it's double that. According to an SEC filing the plan is to grow its units by between 8% and 10% per year "long-term" but by only 3.5% for 2014.
Let's be generous and again for simplicity and use 10% for El Pollo Loco and 5% for Popeyes. It sounds like faster growth for El Pollo Loco, and it is in terms of percent, but the reality is 10% of 400 restaurants is still only 40 while 5% of 2,200 for Popeyes is still over 100. Popeyes is growing, and expected to keep growing, its unit count at a much faster clip. Even if El Pollo Loco hits 10%, that pace would take over 20 years to grow to catch up just to where Popeyes is now here today. According to this article, El Pollo Loco's eventual target is just 2,300 restaurants. (Psst, Popeyes is basically already there.)
I won't even touch the profitability argument since, for now, Popeyes wins hands down on a per-restaurant match-up, but I need to be fair as that can always change in the future through cost cutting, efficiencies of scale, menu changes, etc. so let's just assume going forward they are similarly successful in terms of net profit margins.
The only thing we are left with that gives El Pollo Loco a meaningful advantage is existing-store sales growth and the speculation of more in the future since average sales per unit growth has been more favorable to Popeyes over the last few years than that of El Pollo Loco suggesting Popeyes has had better instant luck with new store openings. For existing same-store sales growth percentage, El Pollo Loco has been doing fantastic.
But is it enough? The market cap of each puts a rough value of $2.5 million per El Pollo Loco and a $0.5 million per Popeyes. All things being equal, El Pollo Loco is going to need to some show some astronomical existing-store sales growth for its valuation to justify more than 5 times that of Popeyes especially since, again, Popeyes unit numbers are growing faster. The number one quick-service chicken chain is Chick-fil-A with $2.8 million in average sales per unit, or roughly the same as an El Pollo Loco and a Popeyes combined. (A.D.D. moment: when is Chick-Fil-A going public?)
El Pollo Loco is going to need to rise, and rise fast, to become the number one quick-service chicken chain in the United States in order to begin to justify its valuation on a basis compared to Popeyes and even without pricing in any risks or time value of money. Don't hold your breath.
I don't own Popeyes right now, but I think I just talked myself into shorting some El Pollo Loco soon. Let's see how the earnings report looks like on September 4 after hours. I may snag some just ahead of the report.