Zoe’s Kitchen: Were the 2016 Q2 Numbers Really That Bad?

 Price Target $37.00
Link to Newswire Release
August 24, 2016

Yesterday, Zoe’s Kitchen (NYSE: ZOES) reported second quarter results, and at one point during the trading day, the stock traded down 20% over the prior day’s close, recovering a bit  by day’s end to close down 17%.  Were the company’s second quarter results really that bad?  Certainly not.  What we have here is a case of shoot first and ask questions later, or rather, sell first and look at the fundamentals later.  Let’s take a look at the numbers in greater detail.

Zoe’s reported total revenues (restaurant sales and royalty fees) of $66.3 million for the second quarter of this year, or a 21.6% quarter over quarter increase.  The company’s year to date revenues rose by an even more impressive 24.9% over the same period last year.  Yet, yesterday, investors in the company lost $125 million in market cap in a single day.  Why was that?

Management noted that a deceleration in sales trend towards the end of the second quarter and the beginning of the third quarter prompted a reduction of the company’s guidance for fiscal year 2016 as follows:

 - Total revenue of $277 to $280 million, down from a forecast of $277 to $281 million
 - Comparable restaurant sales growth of 4% to 5%, down from 4.5% to 6%
 - Restaurant contribution margin of 20.5% to 20.8%, down from 20.5% to 21%

While some caution should be exercised, company CEO Kevin Miles highlighted the company’s successful store openings and its long-term expansion goals.  And while quarterly revenues missed analysts’ expectations by a mere 1.5%, a 20% haircut in share price seems a bit extreme.  We believe this loss will be recovered over time, especially given the fact that the company has a $30 million credit facility with Wells Fargo, which had no indebtedness as of the end of the second quarter, to supplement its cash position.  We are not seeing any dilution in the near future.  Additionally, solid results in the second quarter in a very challenging environment went unnoticed.

Comparable restaurant sales which increased by 4% for the quarter, consisted of a 0.9% increase in transactions and a 3.1% increase in price.  Year to date comparable restaurant sales increased by a stellar 6.2%, consisting of a 3.7% increase in transactions and a 2.5% increase in price.  The company’s adjusted EBITDA increased by 20.1% and 24.3% respectively for the quarter and YTD over the same periods last year.  And while revenues were rising by 21.6%, operating expenses rose by only 20.2%.  Earnings per share came in at $0.06 versus $0.01 for the same period last year.  Year to date earnings per share came in at $0.13 versus $0.04 for the same period last year.

According to the company’s SEC filing, it opened 20 company-owned restaurants during the first half of the year and re-opened the one in South Carolina damaged by a hurricane last year.  It expects to open another 15-16 restaurants by year end and to double its restaurant base within the next five years.  According to the company, “To increase comparable restaurant sales, we plan to heighten brand awareness to drive new customer traffic, increase existing customer frequency and grow our catering business.”

Next month, the company will debut its adventurous new kids menu, which is intended to appeal to generation Z.  According to the company, “Post-millennials, whom the company views as the ‘no nugget generation,’ are open-minded eaters with sophisticated palates; global influences are the norm.  They desire more variety and meals that are made-from-scratch, and tend to gravitate towards fast casual dining.  The new Zoe’s Kitchen kids menu offers wholesome and diverse selections for their evolving taste buds.”  The selections will incorporate grilling as the predominant method of cooking.  We believe by the fourth quarter, the new kids menu will boost the company’s numbers at least to the middle of guidance, if not back to the top.

Based on our assessment of the numbers, the current stock price, and the upcoming debut of the healthy new kids menu, we are moderately bullish on Zoe’s Kitchen with a $37 price target.

Disclosure:  We are long ZOES.  We do not have a financial relationship with the company.