ZOES IPO'ed today. Growing fast food, Mediterranean style. Interesting concept: Mediterranean cuisine served as fast food with southern charm.
Zoe's Kitchen (ZOES)
Fundamental Grade: A-
Zoe's Kitchen (ZOES), a fast casual restaurant chain serving Mediterranean-inspired food, is set to price its 5.83 million share IPO next week in the $11-13 range. All of the shares are being offered by the company with no selling stockholders. ZOES should have a market cap around $220 million, assuming the mid-point of the expected range, so it's quite small. ZOES does not expect to pay a dividend for the foreseeable future. This deal is being led by Jefferies, Piper, Baird, Wm Blair, Stephens and Stifel.
The Zoe's Kitchen Concept: Bringing Mediterranean to the Masses
Zoe's Kitchen is a fast growing, fast casual restaurant concept serving Mediterranean-inspired dishes delivered with Southern hospitality. In fact, ZOES is already the largest US-based fast casual restaurant concept focusing on Mediterranean cuisine. ZOES offers modified table service where, after ordering at the counter, the customers' food is served at their table on china with silverware. Team members routinely check on them throughout the meal and then bus their table, all without the expectation of receiving a tip.
Its menu offers meals made generally from scratch. ZOES prepares its food using traditional Mediterranean preparation methods such as grilling and baking. There are no microwaves or fryers in its restaurants. The menu offers an abundance of fresh fruits, vegetables and herbs, grains, olive oil and lean proteins. Management likes to say it serves "real food" -- from hummus, made fresh daily and served with warm pita bread, to flavorful salads and kabobs. By real food, ZOES means food made from simple ingredients, such as raw vegetables, fruits and legumes. Also, ZOES serves beer and wine in a majority of its restaurants.
The flavors in its menu are "born in the Mediterranean and raised in the South." Inspired by family recipes, its menu features Mediterranean cuisine complemented with several Southern staples. ZOES offers items such as its Mediterranean Tuna sandwich and entrées such as chicken, steak and salmon kabobs and chicken and spinach roll-ups (tortillas stuffed with feta cheese, grilled chicken, sundried tomatoes and spinach). Each is served with a choice of a side item such as braised rosemary white beans, rice pilaf, pasta salad, roasted vegetables or seasonal fruit.
Its food is sought out as a healthy fast food alternative as its meals are predominantly preservative- and additive-free. Also, ZOES caters to a variety of dietary needs by offering vegetarian, vegan, gluten-free and calorie conscious Simply 500 menu selections. Its menu is appealing during both lunch (60% of revs) and dinner (40%). The average customer ticket in 2013 was $9.57.
Its target customer is educated and affluent women. Its female customers generally lead active lifestyles, have an average annual household income of over $100,000 and a majority of them are college educated. Management believes this demographic represents a highly-desirable customer base. Also, the company believes that its attractive demographic mix, high repeat visit rate and its ability to draw an average of 2,500 customers to each restaurants per week makes ZOES a desirable tenant to landlords.
The chain was founded in 1995 by Zoe and Marcus Cassimus in Birmingham, Alabama. ZOES has grown from 21 restaurants across seven states in 2008 to 111 restaurants across 15 states mostly in the south. Its largest states are Texas (29 locations), Alabama (14), Georgia (13) and North Carolina (11). Most locations are company-owned with just six franchised locations. Its company-owned restaurants have generated 16 consecutive quarters of positive comparable restaurant sales growth, due primarily to increases in customer traffic.
Key Points from the IPO Roadshow
If you really want to get a good handle on whether it's worth investing in ZOES, we think a couple of slides from management's IPO roadshow lay out the case quite well. The first is the average revenue per restaurant. As we mentioned earlier, and as you can see below, ZOES came in at $1.47 million in 2013. This ranks behind only PNRA ($2.48) and CMG ($2.17) in the fast casual segment and it's ahead of recent high profile IPOs NDLS (1.18) and PBPB (1.00). So that's pretty impressive.
Another key stat, in our view, is that while ZOES currently ranks behind larger rivals PNRA and CMG in revenue per store, ZOES is much farther along at this point in its growth cycle than PNRA and CMG were back then. ZOES is currently at $1.47 mln while PNRA and CMG were at $1.27 mln and $1.06 mln, respectively, at the same point in their respective growth stages.
A final stat relates to how early these various restaurant chains are in their respective growth cycles. ZOES compared its current restaurant count relative to what it sees as its potential. It currently has 111 stores and it sees 1,600+ potential long term. That works out to only 7% of its current potential. NDLS has 380 locations and 2,500 potential locations for a 15% figure. PNRA is at 44% (1,777 stores vs potential for 4,000) and CMG is at 46% (1,595 vs 3,500). The point here is that ZOES management believes it is just starting to scratch the surface of its potential so there is a lot of growth ahead. Of note, ZOES believes it can double its restaurant count within four years.
Aggressive Expansion: In 2012, ZOES opened 16 restaurants, and in 2013, it opened 27 restaurants. In 2014, the company plans to open 28-30 restaurants. The goal is to double its restaurant base in the next four years. Management believes its concept has resonated with consumers, which has facilitated strong restaurant growth over the past several years, and since 2008, ZOES has not moved or closed a single restaurant. ZOES believes it's in the early stages of its growth trajectory as they see a long term total restaurant potential in the US in excess of 1,600 locations.
Financials
Taking a quick look at the financials, they are a bit of a mixed bag. As you'll see in the table below, ZOES is not profitable but they do have strong top line growth. Revenue grew by 59% in 2012 then by 46% in 2013 to $116.4 million. Much of this is being fueled by ZOES' aggressive restaurant expansion. And that growth is expected to continue as management has set a goal of doubling its number of locations within four years and they see a long term potential of 1,600 locations (they ended 2013 with 102 locations).
However, it's not just new locations that are driving the growth. As mentioned earlier, ZOES has also seen a nice increase in average revenue per location: $1.21 mln in 2010 then $1.30 mln then $1.42 mln and then $1.47 mln in 2013 as they seek to maximize production at each location.
In terms of margins, as you can see in the table below, ZOES has very thin operating margins, in the low single digits. They are spending a lot on the expansion, so the combination of those costs coupled with new restaurants taking time to reach strong operating efficiencies (it takes time for consumers to know those new locations are there), that's taking a toll on margins. Also, while ZOES likes to brag that its revenue per store is above where CMG and PNRA were at this point in their growth, if memory serves, CMG and PNRA did have better margins.
The good news is that adjusted EBITDA margins in the 9-11% range, in recent years, are pretty good. The long term goal is for that to be 20+%. Also, restaurant contribution margin in the 20% range is good to see. Contribution margin represents the portion of revenue that is not consumed by variable costs and so it contributes to the coverage of fixed costs. On a final note, the balance sheet is in good shape with very little long term debt. Pro forma long term debt is under $4 million while pro forma cash will be in the $30 million range following this offering.
Valuation
We ran a scenario generator based on where ZOES may open next week. We think it makes more sense to compare ZOES to NDLS and PBPB as they are more similar in size. As you can see, ZOES is probably reasonably priced relative to its peers if it opens at $20 or below. If it pops much beyond that, its valuation would be stretched. Although with an average revenue per store of $1.47 mln, it probably deserves to trade at somewhat of a premium as NDLS ($1.18 mln) and PBPB ($1.00 mln) do lag a bit on this metric.
Conclusion & Briefing.com Grade: A-
Overall, we are fans of ZOES. There are a lot of positives here. They are an early stage growth story with a goal of doubling their number of locations within four years and they have a long term goal of 1,600+ locations. Also, since 2008, ZOES has not moved or closed a single restaurant so the concept does seem to work. We also like the store metrics. They have posted double digit same store growth in three of the past four years and ZOES has been steadily increasing its average revenue per store which indicates to us that there is good word of mouth. We also like that they are a pretty unique concept. They are basically taking Mediterranean cuisine to the masses. Mediterranean options are typically limited to full service restaurants, so to adopt it for the fast casual market segment is pretty intriguing.
It's not an entirely clean story. The company is not yet profitable as they have been spending a lot on their aggressive expansion plans. And that's another concern. Restaurant unit growth is great to see, but it can be a mistake to expand too quickly. ZOES seems to be handling it ok thus far, but it's a bit of a concern. Another slight concern in that same store sales tailed off in 2013. After three years in the +11-12% range, it tailed off to +6.9% in 2013. Maybe expecting double digit comps every year is not realistic, but that's a metric to watch going forward. Our hope is that their aggressive expansion plans is not causing ZOES to take their eye off the ball on the current locations.
While there are a lot of positives here, investors may be a bit wary after getting burned by the Potbelly (PBPB) IPO in October 2013. Both are small, early growth stage, regional fast casual restaurant chains so many will draw a parallel. It priced at $14, opened at $28.66 and traded into the low-$30's on its first day. The stock has since been cut in half. So just be careful about chasing a pop higher.
In spite of those concerns, we think ZOES will generate a good deal of interest when it prices next week. It has a tiny float (5.8 mln shares) and it's an attractive growth story with a unique concept. The underwriters (Jefferies, Piper, Baird) are good although this is not a Goldman or Morgan Stanley deal. This is a slight negative but probably not a big deal. Overall, we think this concept has a good deal of potential.
