Shares of Zoe's Kitchen (ZOES) popped in the company's first day of trading as a public company. Zoe's is the latest in a string of recent successful restaurant IPOs that fetch significant growth premiums based on the potential for nationwide expansion; Noodles & Company (NDLS -0.42%) and Potbelly (PBPB 0.58%) have also gone public with the expectation that each may be the "next Chipotle Mexican Grill" (CMG -1.33%). The roller coaster that has followed each IPO demonstrates just how difficult it can be to sift through the hype and locate the next great growth story:
So, is Zoe's the "next Chipotle" or simply another over-hyped restaurant IPO destined to return to reality?
Lofty valuation
At the end of its first day as a public company, Zoe's commanded a TTM price-to-sales ratio of over 4.0; this multiple is significantly higher than the 1.7 P/S ratio for Potbelly and 3.0 P/S ratio for Noodles now that shares of both companies have drifted lower following their IPOs. However, Zoe's trades at a lower multiple than Chipotle's P/S ratio of 5.1. To assess the reasonableness of this valuation, it is important to look at the relative size of Zoe's and its growth plans.
Significant growth potential
Zoe's has just 111 restaurants in 15 states. The company plans to add 28-30 in 2014 and believes that it has the potential to grow its footprint to more than 1,600 locations in the United States. A visual look at the company's footprint demonstrates how the company is just starting to scratch the surface:
Source: Zoe's Kitchen Form S-1
With almost a third of its locations in its home state of Texas and none in highly populated states like California and New York, Zoe's is just starting to scratch the surface of its expansion plan. This is significant because it provides investors with an opportunity to get into a growing restaurant concept closer to the ground floor; Noodles had 318 locations at year end, while Potbelly had 319 locations.
At a third the size of Noodles and Potbelly, Zoe's is early enough in its growth story to report some staggering growth numbers, including a 560% increase in revenue over the past five years from just $21 million in 2009 to $116 million in 2013. This trend is likely to continue based on the expectation that Zoe's will roughly double its store count over the next four years.
Depth to the growth story
While the potential to grow its footprint more than 1,400% (if the company can reach 1,600 locations) is a strong pillar of the investment thesis, there is also a history of strong same store sales (SSS) growth to consider.
Source: Zoe's Form S-1
Zoe's has demonstrated the popularity of its concept and the acumen of management to drive growth through very impressive SSS growth including 13.4% SSS growth in 2012 and 6.9% SSS growth in 2013. To put Zoe's performance in perspective, a key driver behind Potbelly's fall to reality is SSS growth that has been no higher than 3.4% in the past five years, including just 1.5% in 2013. In this context, Zoe's performance has been remarkable.
Use of IPO proceeds
IPOs can occur for a number of reasons that are reflective of the company's goals and plans for the future. In the case of Zoe's, the company intends to use the proceeds to repay its entire debt balance and also finance the growth of new stores. This should be viewed as a positive for investors, since the company will be armed with the funds to drive its next wave of restaurant openings while also obtaining the financial flexibility that comes with not having any long-term debt.
A differentiated concept
Contributing to Zoe's strong growth in both location count and SSS is the fact that the company's concept of "serving a distinct menu of fresh, wholesome, Mediterranean-inspired dishes delivered with Southern hospitality" is differentiated from the competition within the fast casual marketplace. By carving out a unique niche, Zoe's has less direct competition than Potbelly and Chipotle have within the crowded sandwich and burrito markets, respectively.
Zoe's should not be automatically lumped into the same category as Noodles and Potbelly given its unique menu and the significantly smaller size. These characteristics combined with a fantastic growth trajectory are reasons to expect that Zoe's will provide better long-term returns for investors than Noodles and Potbelly. However, with a market capitalization of less than $500 million and a premium valuation, investors should expect to see significant volatility along the way.
As a result, it is advisable to invest gradually in Zoe's in order to acquire shares at better value points than what can be obtained in the days immediately following the IPO. As always Foolish investors should do their own research before making any investment decisions.
