Zoe's Kitchen (NYSE:ZOES) is a restaurant concept offering Mediterranean food, made fresh to order, delivered with Southern hospitality. The healthy options offered by a Mediterranean diet are well documented, as is America's increased interest in eating a healthy diet. ZOES meets this demand head-on, and is in the early innings of bringing this successful new concept to the market. Recent channel checks, and comments from management on non-deal road shows, indicate a very strong Q3 and Q4 outlook. Since their IPO, ZOES has faced constant skepticism about the potential of their brand, as people question how fast, or how big they can grow. Now that we are 18 months past the IPO, and ZOES has executed their growth plan nearly flawlessly, it's time to put these unfounded criticisms to rest.
Positive Commentary on Near-Term Results
The ZOES management team spent some time on the road in late September and early October , connecting with both existing and potential investors, to talk about their progress and increase exposure to the company. Typically sell-side analysts don't want to spend a day of their time promoting a company to their clients unless they think the company is executing well, so this is usually a very good sign. But in this case, after hearing management, analysts came out even more positive, resulting in a price target increase from Stephen's. ZOES was also initiated with a buy rating by Maxim in the past two months.
In addition to the non-deal road shows done by the company, they also participated in the Stifel Consumer Conference. The management team was very positive at the conference, showing confidence in their near term results, and reiterating their excitement for their long term goals. The third thing that gives us confidence about the third quarter results is recent channel checks, both internally, and externally from several sell-side analysts, that confirm the belief that the company is executing on all levels.
The Truth about ZOES Growth Potential
It's very impressive that ZOES is consistently growing same store sales above 5.5%, but their largest growth opportunity is in expanding their footprint from 150 stores to over 1,600. Although some people, including this Seeking Alpha writer, have been skeptical of this number, they fail to give any reason why it can't be achieved. Rather than join him in making unfounded speculation about future store counts, I'd rather look at the facts, and see how ZOES has performed in their most established markets.
Although ZOES is far from saturated in Texas, (their Texas stores have increased 26% this year, from 34 to 43), it provides the best examples of how many stores a populated metropolitan area can support. The Dallas area is home to 19 ZOES restaurants, and those are almost exclusively located in Dallas and Plano. With only one restaurant in Fort Worth, and none in Irving or Arlington, the area could support 30 restaurants or more from the chain. Houston is another great example. While not yet close to saturated, that market already has 13 ZOES restaurants. Even with the floods, and other weather issues early in the year, and an economy hampered by oil prices, they've been able to generate great same store sales growth and add locations. That speaks to the strength of brand and demand for this concept, and gives you a good idea of what it can do in other metropolitan areas around the country.
ZOES has also been very successful outside of large metropolitan areas. They are building restaurants in cities like Destin, FL, Peachtree City, GA, and Dothan, AL, all cities with far less than 75,000 people. With the opportunity to put 30+ restaurants in large metropolitan areas, and add locations in small and mid-sized cities around the country, it's not hard at all to come up with a scenario where ZOES opens 1,600 locations.
Another unfounded argument about ZOES growth potential is that this concept won't be successful in northern states. In order to get to 1,600 locations, ZOES will need to be successful outside of southern states. The good news is, they have already proven the concept in the northeast. There are currently 8 ZOES restaurants in Pennsylvania, 6 in Maryland, and 2 in New Jersey, all of which have proven that there is a demand for a fresh new concept of healthy food in all parts of the country.
The Counter to the Short Thesis
Since becoming a public company, ZOES has delivered quarterly SSS growth between 5.6% and 7.9%. Their existing stores have proven that there is demand for this concept, and that they can execute on the growth. Their long term goals related to store count are supported by their ability to put a high number of stores in each market they enter.
Despite this success, the stock has a very high short interest, at over 30% of the float. The stock is virtually impossible to short today because you either can't get a borrow, or you pay a 50% to 60% rate. Put options on the stock have premiums built into them that make no rational sense. Despite constant short selling, and a very difficult stock market in general, ZOES stock has held up very well. The recent dip provides an excellent buying opportunity, and potentially the last one you will see at this level. The company continues to open stores and deliver on growth. Pair that with short borrow rates over 50%, forcing short sellers to cover, and we could see a very strong rally into year-end.
Disclosure: I am/we are long ZOES.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.