What I’ll Be Watching When Zoe’s Kitchen Reports Earnings

After two consecutive quarters of negative comps, Zoe's Kitchen shares are down nearly 50% year to date. The company will report its third-quarter earnings on Nov. 9, and by all appearances, this is looking like another rough quarter. Between recent disappointing industry data, hurricanes in two of Zoe's larger markets, declining margins, and lowered ambitions for new store growth, I'm not expecting a whole lot of good news from the Mediterranean fast-casual chain. Here's a look at how the stock's been doing and the items I'll be watching closely for any signs of a turnaround.

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Will comps continue to deteriorate?

Zoe's comparable-restaurant sales growth in 2017 has been disappointing, as the company reported the first two comps declines in its history as a public company.

Data source: Zoe's Kitchen.

Even though Zoe's is anticipating some improvement with its full-year guidance, the wide range gives a pretty clear indication that management doesn't have a great handle on where sales are headed for the remainder of 2017.

That said, on the last conference call, Zoe's said it was seeing positive comps in the early weeks of Q3, attributing the boost to several new menu items. Equally intriguing was that both the average ticket as well as customer traffic had increased.

While that might have some holding out hope for a comps recovery when the report comes out, the latest industry data make that look unlikely. According to Black Box Intelligence, during the third quarter, average restaurant comps declined 2.2%, while traffic fell 4.1%.

What's even worse for Zoe's in particular is that it has a significant presence in the two states hit hardest by hurricanes Harvey and Irma. With 55 locations in Texas and 22 in Florida, roughly a third of Zoe's stores may have been impacted by Harvey and Irma. Black Box Intelligence reported that "the effect of the storms on restaurant sales was huge for the areas they hit. Texas reported same-store sales growth of -5.1 percent during August and Florida -6.2 percent during September."

Are margins headed lower?

Zoe's used to enjoy fairly robust restaurant contribution margin rates of 20% and above. But higher labor costs have weighed on the company over the past few quarters. Additionally, Zoe's has opened a lot of new restaurants recently. Those restaurants are generally less efficient during their first couple of years of operation because they tend to ring up lower average sales and higher operating costs.

Data source: Zoe's Kitchen.

The company's full-year guidance indicates that it expects lower restaurant-level profitability through the rest of 2017. By my math, to hit a 18.65% margin -- the midpoint of management's guidance -- it's looking like restaurant contribution margin would have to clock in somewhere in the high-17% range for the remainder of the year.

Store growth targets have been scaled back -- for now

With its comps and margins suffering for now, Zoe's announced it would slow its rate of expansion for next year. It currently plans to open 25 to 30 new restaurants in 2018 -- which would represent roughly 11.5% annual store growth.

Given that the company was taking on debt to finance its store growth, this move makes sense. But it means Zoe's can no longer count on the 20%+ annual store growth of the past to fuel revenue and earnings. For a company that has ambitions for 1,600 locations -- compared to just 232 stores at the end of last quarter -- investors are obviously not thrilled that Zoe's is hitting the brakes on store growth so early. So look for any updates to management's plans for store growth in 2018, especially if comps come in better than expected.

The environment for restaurants in general continues to be challenging, and Zoe's certainly has its work cut out for it as it attempts to rebound from an ugly start to the year. However, with the stock so beaten down and expectations running extremely low, I also wouldn't be surprised to see the stock jump if comps begin trending the right direction again.