There is a case to be made for Zoe’s Kitchen Inc (NYSE:ZOES). Zoe’s Kitchen stock does not at all look cheap on an earnings basis, with analysts still projecting a full-year loss for 2018. But the price-to-sales ratio is below 1.0, and the nature of the restaurant business is that margins can rise very quickly — if sales rise.
So if Zoe’s Kitchen can grow, it can grow into a still-reasonable valuation. The problem for Zoe’s Kitchen stock at the moment is that growth is tough to come by. ZOES stock did rise 7% on Friday, despite opening lower and despite what looked like disappointing fourth-quarter results. But for the full year 2017, comparable store sales fell 2%. Adjusted EBITDA declined modestly — despite the company opening 39 new restaurants during the year.
That leaves Zoe’s Kitchen stock, at a current price near $15, as almost a straight bet. If Zoe’s can get same-restaurant sales positive, and leverage fixed costs, the stock should rise. If it can’t, the stock should fall. The issue, at the moment, is that there seems little reason to bet on Zoe’s.
Zoe’s Kitchen Becomes a Turnaround Play
It really wasn’t that long ago that Zoe’s Kitchen stock looked like an intriguing growth play. InvestorPlace‘s Jeff Reeves made the case for the stock back in 2015, just a year after the company’s IPO. Zoe’s Mediterranean menu gave it an interesting niche.
“Fast casual” plays like Chipotle Mexican Grill, Inc. (NYSE:CMG) and now-private Panera Bread were all the rage. Zoe’s Kitchen stock would clear $45 in the middle of 2015, as investors saw an attractive concept with huge room for expansion.
Zoe’s has grown its store count sharply. Per the company’s 10-K, Zoe’s has moved from 21 restaurants at the end of 2008 to 243 nine years later. But the problem is those restaurants simply aren’t doing all that well. Same-restaurant sales declined to a still-solid 4% in 2016 — and then dropped to -2% last year. Restaurant-level margins have fallen 260 bps as well.
Guidance for 2018 doesn’t look much better. Same-restaurant sales are guided flat to up 2% — implying a still-negative two-year trend. Restaurant-level margins are expected to compress further. 25 new restaurants will still add ~10% to the total store count – but total profits are likely to be relatively unmoved. What looked like the next Chipotle now looks like a business in need of a turnaround.
Can Zoe’s Turn Things Around?
That turnaround is going to be tough. Restaurant operators across the space are dealing with higher costs. Labor inflation continues to be an issue. Input costs are rising as well.
That alone is one reason why there’s such a huge divergence between the market’s attitude toward franchisors and operators. Franchisors are worried about revenue alone; operators have to concern themselves with costs, too. Domino’s Pizza, Inc. (NYSE:DPZ), a franchisor, has one of the highest multiples in the restaurant space. Even McDonald’s Corporation (NYSE:MCD) has soared amid optimism toward its refranchising efforts.
Meanwhile, an operator like Brinker International, Inc. (NYSE:EAT) trades at a single-digit EPS multiple. Those operators are seeing intense pressure on both sides. Consistent promotional activity from rivals hurts pricing; labor and food costs are rising at the same time.
It’s asking a lot of Zoe’s Kitchen to be able to walk the tightrope. But it’s not impossible. The company’s menu is distinctive. It should end 2018 with about 268 restaurants; it’s said in the past it can get to 1,600 — six times that many. Zoe’s can also take the franchise path itself at some point (it ended 2017 with 3 franchised locations). Margins will improve if sales do, with the company saying on the Q4 conference call that positive 2% same-restaurant sales would keep margins intact. If an investor believes those sales can turn positive consistently, Zoe’s Kitchen stock is a buy.
Zoe’s Kitchen Stock: Buy or Sell?
Again, it’s tough to value ZOES on a net income basis. On an EBITDA basis, ZOES trades at about 13x — well above struggling operators, but below the 16x+ seen at most franchisors. The EV/revenue multiple is a bit over 1.0 — higher than that of Brinker, but well below that of Chipotle at close to 2.
Both of the latter metrics suggest upside — but, again, only if Zoe’s can drive growth. And, from here, it seems wisest to wait for some evidence on that front. A positive 0.3% comp in Q4 was a step in the right direction — but just a step. The company’s own guidance suggests only modest improvement in 2018.
For investors willing to wait out the story here, and who believe in the Zoe’s concept, $15 probably is an attractive price. For the rest of us, though, a little more clarity would be very helpful.
As of this writing, Vince Martin has no positions in any securities mentioned.