The rise of the fast-casual restaurant concept has led to huge numbers of different companies seeking to cash in on its success, and Zoe's Kitchen (NYSE:ZOES) tapped the Mediterranean cuisine niche for its foray into the space. After going public early in 2014, Zoe's has made a splash, with impressive share-price performance as investors anticipated a smooth upward trajectory for its business. Yet despite third-quarter results last Thursday that largely confirmed the success that the company has had in establishing and expanding its business, Zoe's shareholders weren't convinced about the pace of its future growth, and shares fell in response. Should long-term investors see the dip as a bargain opportunity or as a warning of a difficult future? Let's look at how Zoe's Kitchen did this quarter and whether it will be able to sustain its growth into 2015 and beyond.
Zoe's delivers hot earnings but lukewarm guidance
The headline numbers for Zoe's Kitchen were quite strong. Total revenue soared by 50% to $43.6 million, with restaurant sales representing nearly all of the company's sales and rising by a similar figure. Comparable-restaurant sales rose by 5.9%, with favorable price increases, heavier traffic, and a customer shift to premium menu items all contributing to lifting comps for those restaurants that have been open for 18 months or longer. On the net income front, one-time charges held back GAAP earnings to $0.02 per share, but on an adjusted basis, EPS of $0.04 was a penny higher than investors had looked for from the Mediterranean chain.
In addition to relative strength in comps, an expanding store count obviously played a huge role in Zoe's Kitchen's overall results. The company opened four more restaurant locations during the third quarter, bringing the total number of new Zoe's Kitchen restaurants opened in 2014 to 24 as of the end of the third quarter.
Still, some adverse trends weighed on Zoe's bottom line. Margins fell almost two full percentage points to below 20%, as rising prices of beef and poultry combined with higher overhead expenses to adversely affect the company's profitability.
In addition, Zoe's Kitchen's guidance for the remainder of 2014 fell short of the most optimistic views from investors tracking the stock. Restaurant sales of $169 million-$171 million and growth in comps of 6%-6.3% would be slightly lower than the consensus among investors, and further margin deterioration would again challenge Zoe's ability to satisfy shareholders who want to see more of the huge revenue growth fall through to raise profits.
What's happening next for Zoe's Kitchen?
Since the end of the quarter, Zoe's has moved forward even further in its expansion plans. The company has already opened five new restaurants since early October, and the purchase of three more franchise restaurants in Louisiana a couple of weeks ago will expand Zoe's company-owned network of locations to an even greater extent, as well as giving it two more restaurants under development for future expansion. As of Nov. 20, the company had 128 company-owned restaurant.
Yet investors still have to be concerned about the recent exodus of major shareholders, as a secondary offering of 3.8 million shares at $32 per share represented more than 20% of Zoe's Kitchen's outstanding shares. Institutional investor Brentwood Associates is selling the lion's share of the stock in the offering, with more than 2.9 million shares up for bid. But several executive officers and directors also sold stock in the secondary offering, and that's not the vote of confidence that long-term investors like to see from the people running their company.
After the announcement, Zoe's Kitchen's shares fell 4.5% on Friday. Until Zoe's Kitchen can demonstrate that it will be able to sustain and even grow comparable-restaurant sales, it will be tough for the stock to regain its footing and continue producing the gains that have impressed early shareholders so far.