Is Zoe's Kitchen a Hot Hors d'oeuvre?

Shares of Zoe's Kitchen served up a hot helping of share price appreciation on its first day of trading. Can the Mediterranean-style fast-casual chain keep cooking up a soaring share price or is the business about to get stale?

Apr 17, 2014 at 12:00PM

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Source: Zoe's Kitchen. 

After rising 65% on April 11 when the company went public, shares of Zoe's Kitchen (NYSE:ZOES) are probably looking pretty expensive. With the company being the largest fast-casual restaurant chain in the U.S. that focuses on a Mediterranean menu, it's not hard to understand why demand for a piece of the business was so strong. Moving forward, does an investment in Zoe's make sense? Is there still plenty of upside to be had, or is there simply too much risk from these levels?

Zoe's is a real growth engine
Over the past three years, Zoe's has seen a rapid increase in its annual revenue. Between 2011 and 2013, the company saw revenue jump 137%, from $49.2 million to $116.4 million. According to the company's prospectus, its rising top-line results were driven by a combination of increased store count and improving comparable-store sales.

During this time frame, the company's store count skyrocketed by 79%, from 57 locations to 102. This jump came in spite of one net store reduction in its franchise category and stemmed entirely from organic growth. Meanwhile, comparable-store sales grew, in aggregate, by 36%.

ZOES Revenue (Annual) Chart

ZOES Revenue (Annual) data by YCharts.

This growth rate is far greater than that experienced by both Noodles & Company (NASDAQ:NDLS) and Potbelly (NASDAQ:PBPB), two fast-casual chains not much larger than Zoe's. Over the past three years, Noodles & Company saw its revenue grow 37%, from $256.1 million to $350.9 million, while Potbelly's jumped just 26%, from $238 million to $299.7 million.

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Source: Zoe's Kitchen.

In the case of Noodles & Company, the company's revenue growth came from a combination of an increased restaurant count and higher comparable-store sales, but not to the extent that Zoe's enjoyed. During this three-year period, Noodles & Company grew its number of locations by 34%, from 284 to 380, while comparable-store sales increased only 14.3% in aggregate.

Potbelly performed less well on both of these metrics. Between 2011 and 2013, the company's store count (company-operated only) rose only 26%, from 234 locations to 296. Comparable-store sales also saw lackluster improvements over this time frame, with an aggregate increase of 7%.

Revenue isn't everything
In terms of revenue, Zoe's has been a fantastic business, especially when placed next to its fast-casual peers. However, it's important to remember that revenue growth isn't the only factor in evaluating a business's prospects. In the three-year period assessed, Zoe's saw its higher sales accompanied by larger net losses, which widened from $0.03 million in 2011 to $3.7 million in 2013.

ZOES Net Income (Annual) Chart

ZOES Net Income (Annual) data by YCharts.

In contrast, both Potbelly and Noodles & Company have seen a net profit each of the past three years. Noodles & Company's bottom line grew by 76%, from $3.8 million in 2011 to $6.7 million in 2013. This jump in profits came from the company's rising revenue but can also be attributed, for the most part, to lower interest expense.

Potbelly's earnings record hasn't been quite so smooth. After seeing net income of $7.2 million in 2011, the company's profits jumped to $24 million in 2012 and then fell 95% to $1.3 million in 2013. In spite of higher sales, Potbelly's net income has been negatively affected by an increase in the company's cost of goods sold, from 78.2% of sales to 79.4%, while its selling, general, and administrative expenses rose from 11.9% of sales to 13.7%.

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Source: Zoe's Kitchen.

Foolish takeaway
Based on the data provided, it's clear that Zoe's has been a strong growth business. What's not clear is how well the company will fare moving forward. Yes, revenue has been on the incline, but its mounting net losses should cause investors in the business to be cautious.

This does not mean that an investment in the chain won't pay off (it could pay off handsomely if management can continue its rapid growth while converting to a profit), but it does imply that there's some extra risk involved. Furthermore, with shares of Zoe's trading at 3.9 times revenue, it's far more expensive than Noodles & Company's 3 times and Potbelly's 1.7 times. These factors should weigh on any investor's mind in deciding how much of their portfolio, if any, they want to allocate to Zoe's.

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Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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