El Pollo Loco Reports Thursday Evening - Will Not Break Out Of Trading Range

Roger Lipton profile picture
Roger Lipton
190 Followers

Summary

  • LOCO has been around a long time, maintaining market share in a difficult environment.
  • Still challenged in new markets, Houston in particular.
  • Still 43% owned by private equity sponsor. Too cheap for them to sell, not cheap enough for us to buy.

Upcoming Earnings Release & Conclusion

El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) is scheduled to report its 16Q3 earnings Thursday, November 3rd after the market closes with a conference call at 5PM EST. Per Bloomberg, of the 7 sell side analysts providing estimates, the consensus for revenue, company store comps and EPS of $97.3M (Range $96.0M-$98.5M), 2.6% (Range 2.5% to 2.8%) and $0.19 (Range $0.18-$0.19), respectively, are substantially unchanged since the Q2 report, though revenue and Q4 EPS and FY17 estimates were lowered modestly. Also, according to Bloomberg, the mean target price is $15 (range $13-$18) which is down less than $1 since the Q2 report. Early last month the company announced the selection of San Diego Vitro as its advertising agency.

Nothing wrong with this well established concept that a 10% improvement in sales wouldn't fix. Management is working hard at all the right things, but the macro economy and stiff industry specific competition continue to hinder a fundamental upside breakout. The stock has been in a trading range, up or down two points from the current price, depending on the general market. I expect that to be the case for the time being, since there are no fundamentals, macro or micro, that seem able to affect that situation.

LOCO: Company Overview

El Pollo Loco Holdings, Inc., became publicly held in November 2014, is headquartered in Costa Mesa, California, and is the operator (as of 6/29/16) of 188 restaurants and franchiser of 251 locations. It is worth noting that 72% of franchised restaurants have been with the system for over 20 years. El Pollo Loco quick service restaurants serve a differentiated menu based on fire-grilled citrus marinated, Mexican inspired, chicken items. The first restaurant opened in Los Angeles in 1980 and the restaurants are still heavily based in the western U.S., California (with 80% of the total system in the greater L.A. area), Arizona, Nevada, Texas and Utah. LOCO operates within the Limited Service Restaurant (LSR) segment, but considers that it offers the food and dining experience of "fast casual" such as Panera's (that typically has a check of $8.00-$12.00 per person) with the speed, value, and convenience of a lower priced ($3.00-$8.00 check) Quick Service Restaurant. The Company also believes that it stands to benefit from the trend toward healthier eating as well as the increased acceptance of Mexican food in the U.S. The majority of entrees are made from scratch, including the bone-in chicken and chicken breasts, rice, salsas, guacamole, and cilantro dressing. The family sized chicken meals comprised 28% of company operated sales in 2015. Half of sales are generated at lunch and half at dinner, relatively rare within the restaurant industry.

A typical restaurant ranges in size from 2200 to 3000 square feet with seating for approximately 70 people. Most recently, new units have cost $1.45M for building and equipment on a leased site. Average unit volumes have been $1.9M, with company store level EBITDA at 21.7%, generating approximately 28% cash on cash return at the store level (for the relatively "mature" base). New units are modeled to reach this operating level by the third year of operation. As of 12/31/2015, approximately 70% of the system had been remodeled to the new "Hacienda" design, which typically increased sales by 3%-4%. The remainder of the system is expected to be remodeled by 2018.

According to its January 2016 Presentation, the Company expects to grow the unit base, by 8-10% per year on a long term basis (18-22 company operated, and 10-15 franchised locations in 2016). They project that with same store sales growth of 2.5-3.5% annually, corporate EBITDA can grow at 13-15% per year, and EPS can compound at 15-20%. In our "unfiltered" fashion, we should note that while Pollo Loco is a very strong participant in the California (Los Angeles, in particular) market where their long term presence has created substantial loyalty, the Company has had less tangible success (so far) in establishing a beachhead in more distant markets such as Houston. The concentration in California also exposes LOCO to upward pressure on labor costs, though competitors will face the same problem, as California is leading the national charge toward a much higher minimum wage.

LOCO's largest stockholder is Trimaran Capital, LLC, a private equity firm, which effectively owns approximately 43% of the company, creating an overhang on the stock.

Since the company became public, total LOCO locations have increased 10.3% (+11.2% Company stores, +9.6% franchised stores) together with comps (which have tailed off from the 7% average achieved in its first 5Q's, to a 4.4% average in the last 5 Q's) have driven revenues in the T12M ended 16Q2 up a total of 6.4%. During the same period, EBIT levels have dropped from a peak of $51.5 in 2014 to $46.0M in the T12M ended 16Q2, while EBIT margins dropped from >14% to 12.5% ). Similarly, ROIC's have dropped from 24-25% levels at the time of the IPO to 6%-7% levels in the past year. In the 12 months ended 16Q2 cash flows from operations were $49.5M, which net of cap ex of $36.3M, left free cash flows of $13.2M. Currently, the ratios of total debt to EBITDA and lease adjusted debt to EBITDAR were 1.9X and 3.4X, respectively.

LOCO: Current Developments Per Q2 Report

LOCO shares rose over 8% after second quarter operating results beat estimates by a penny a share and revenues were higher by about 1%. The move in the stock reflected more about sensitivity to "expectations" than the results themselves. There was special comfort, in this challenging retail environment, that transactions at company operated restaurants improved 2.7%, with same store sales up 2% (up 2.7% at franchised locations), the difference being a lower average ticket due to comparisons with higher priced items a year ago. Cost of goods improved by 270 basis points, primarily due to lower chicken prices, and labor was up by 160 bp. As we have been predicting industry wide, occupancy expense trended upward by 70 bp ("primarily due to rent expense on new and renewed restaurant leases"). Depreciation and amortization increased by 50 bp YTY, predictably driven "by our new store development as well as our remodeling program". G&A also was higher, by 130 bp total including non-recurring legal costs, but 100bp outside of that item. Overall, even with relatively firm sales, the quarter reflected LOCO's "battle for margin survival", typical of the restaurant industry these days, bearing the cost of higher labor, higher rent, higher G&A, partially offset these days by lower commodity costs.

In terms of guidance going forward, management shaved the balance of the year by a penny or two, likely reflecting the ongoing sales challenge in Texas. As discussed on the conference call, Houston has been especially problematic, no doubt affected by the energy industry, and LOCO is trying to stimulate sales with aggressive couponing, expected to cost a material five hundred basis points in food expense. Dallas is described by management as less of a problem, and the new "Vision" prototype is going to be rolled out in new locations as well as remaining remodels. The 2016 unit total of new locations is expected to come in at 17-20 company, and 10-15 franchised for the year. Restaurant contribution margin, no doubt largely affected by Houston ("Houston, we have a problem", from "Apollo 13", for our younger readers) is expected to complete the year at 20.8-21.2%, down from 21.7% in 2015.

This article was written by

Roger Lipton profile picture
190 Followers
Roger Lipton @RogerLipton (Twitter) has followed the restaurant/retail industry for four decades, as an analyst, investment banker, investor and advisor. He manages an investment partnership, within a family office, with a particular emphasis on restaurants and retailing, with a secondary concentration in precious metals relating to international monetary developments. He tweets on a regular basis @RogerLipton, and is the purveyor of an interactive website@ http://www.rogerlipton.com
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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