Please ensure Javascript is enabled for purposes of website accessibility

3 Things That Zoe's Kitchen Got Wrong in Q3

By Rick Munarriz – Nov 15, 2016 at 10:45AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The fast-casual dining chain had a rough third quarter, hosing down its guidance yet again for all of 2016.

Image source: Zoe's Kitchen.

Share's of Zoe's Kitchen (ZOES) moved lower on Tuesday following another rough quarter out of the fast-casual chain specializing in Mediterranean dishes. The stock is closing in on last month's all-time low.

I singled out three things that Zoe's Kitchen had to do to get back on track last month, and it has fallen short on all three fronts. Let's revisit those three items, and how things haven't gone Zoe's Kitchen's way.

1. Fast casual needs to win back Wall Street's respect

A lot of fast-casual concepts went public in recent years, riding the coattails of Chipotle Mexican Grill (CMG 0.93%). The burrito roller shook up the industry with its assembly-line eats, offering casual dining quality food with the convenience of fast food. 

Zoe's Kitchen was a solid company before its 2014 IPO, but its debut as a publicly traded company probably wouldn't have happened if underwriters weren't knocking on the doors of growing fast-casual concepts that they could market as the next Chipotle. Fast casual was hot, and Zoe's Kitchen was one of the many market beneficiaries. 

We've seen how things have fallen apart at Chipotle since food-borne illness outbreaks smacked the brand late last year. It hasn't been able to bounce back, cranking out four consecutive quarters of double-digit declines in comps. Its latest results were rough, sending the stock to a fresh three-year low. Zoe's Kitchen was the right stock at the right place when it went public in 2014, but now it's definitely not in the right place. 

2. The market needs to redefine its valuation parameters 

Investors overlooked the lofty valuation at Zoe's Kitchen because it was the price of admission to ride a darling in the once hot fast-casual niche. As I pointed out last month, when Zoe's Kitchen stock peaked at $46.61 during the summer of last year it was trading at 466 times that year's eventual earnings and 3.96 times that year's revenue. Now that we've seen the stock shaved by more than half as Zoe's Kitchen's top-line grows and Zoe's Kitchen's P/E and P/S multiples now check in at 205 and 1.6, respectively, based on this year's analyst targets. No one is going to argue that Zoe's Kitchen is cheap even after the stock's massive haircut. However, if it pits its revenue-based multiple to Chipotle, it's looking pretty good for a chain that is still posting positive comps and top-line growth. 

3. Nov. 14 needs to go well

The third and final stipulation to get this turnaround going is that Zoe's Kitchen had to impress the market with its third-quarter results. It was a mixed showing out of the 201-eatery chain. Revenue climbed 19%, just shy of expectations. Its adjusted profit of $0.04 a share fell short of last year's bottom-line results, but in line with expectations given the contracting contribution profit margin that Zoe's Kitchen is experiencing. 

The news gets worse as we belly up to guidance. For the second quarter in a row, we see Zoe's Kitchen hosing down its revenue, comps, and contribution profit margin forecasts for the entire fiscal year. This was the news that clobbered the stock last time out, and the carnage would've been ugly today if it hadn't already shed so much of its value over the past three months.

Zoe's Kitchen investors can find silver linings in the streak of positive comps that is still intact and that the chain is still profitable, at least on an adjusted basis. Marching its way back to market fancy won't be easy, but one way for that to start is for Zoe's Kitchen to stop having to tweak its forecasts lower every three months.

Rick Munarriz owns shares of Zoe's Kitchen. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Zoe's Kitchen. 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.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.