The restaurant industry is famously challenging and competitive. However, it can also be remarkably profitable for companies serving the right menu to a hungry clientele. Shake Shack (NYSE:SHAK), El Pollo Loco (NASDAQ:LOCO), and Zoe's Kitchen (NYSE:ZOES) are three restaurant stocks firing on all cylinders and offering succulent growth potential in the years ahead.
Shake Shack is one of the hottest names in the fast casual restaurant category. The company had its IPO on Jan. 30th, and demand for the stock has been on fire since then.
Management had initially anticipated shares to price between $14 and $16, but investor enthusiasm prompted the company to raise the range to between $17 and $19. The IPO ultimately priced above the range anyway at $21 per share. After some stomach-wrenching up and down moves in recent months, Shake Shack stock is now trading in the neighborhood of $48 per share.
When investing in small restaurant chains with big potential, volatility is often a major risk. On the other hand, these abrupt price movements also show that there is plenty of appetite for high-growth restaurants like Shake Shack among investors.
Shake Shack operates within the fine casual category, offering the ease and convenience of fast casual concepts in combination with higher quality standards and fresher ingredients. Signature items include its all-natural, hormone and antibiotic-free burgers, hot dogs, crinkle-cut fries, shakes, and frozen custard.
Customers cannot get enough of these tasty items -- Shake Shack sales have increased from $19 million in 2010 to $118.5 million in 2014. There is no slowdown in sight judging by recent financial reports: Total revenues -- which include company-owned restaurant sales and licensing revenue -- grew by a mouthwatering 51.5% year-over-year to $34.8 million during the most recent quarter.
Shake Shack has a total of 63 stores, 31 of them domestic and company-operated, five domestic licensed units, and 27 international licensed restaurants. Management believes it has room for at least 450 stores in the U.S. alone, so this growth story could be just getting started.
Zoe's Kitchen is another high-growth play in the fast casual segment. The company serves fresh, preservative and additive-free Mediterranean dishes, prepared daily and delivered with Southern hospitality. The company specializes in fresh soups, salads, and sandwiches with grilled chicken being a big part of its menu.
The company has increased its restaurant base from 31 locations in 2009 to 129 company-owned restaurants and three franchised units at the end of 2014. In the process, total revenues have climbed from $20.8 million in 2009 to $171.7 million last year.
Zoe announced an impressive 39.5% year-over-year sales increase last quarter, with comparable restaurant sales growing 7.8%. The company is still losing money, but profit margins are moving in the right direction: Restaurant contribution margin increased 40 basis points to 18.5%.
Management plans to open between 31 and 33 new restaurants in 2015, so store base expansion should be a considerable driver in the coming year. Looking forward, the company believes it can successfully open and operate 1,600 restaurants locally.
El Pollo Loco
El Pollo Loco offers a simple and competitively priced menu. The company specializes in fire-grilled chicken recipes inspired by Mexican cuisine. The signature product is its chicken marinated with a proprietary recipe of citrus, garlic, and spices, which is the foundation of different menu items and combinations.
El Pollo Loco belongs in the fast casual category, but the company competes at the low-end of the pricing spectrum. Most menu items are priced between $5 and $7, and the average per person spend is around $5.83. This means El Pollo Loco is not only conveniently priced versus other fast casual restaurants -- the pricing is also quite competitive with typical fast food chains.
Since many customers are moving away from fast food due to health considerations, El Pollo Loco is in a position of strength to attract those clients with a healthier menu and competitive prices.
The company is not growing as rapidly as the restaurants above, but the key variables are still moving in the right direction. Total revenue during 2014 was $344.9 million, an 8.1% year-over-year increase on a comparable 52-week basis. Profit margins have consistently expanded in recent years, as the restaurant contribution margin has grown from 19.8% in 2012 to 21% in 2013 and then 21.9% of revenues in 2014.
The company has 172 company-owned restaurants and 243 franchised locations. Management is planning to open 16 new company-owned restaurants and 11 franchised restaurants during 2015, and it intends to deliver unit growth in the range of 8% to 11% in the coming years. Over the long-term, the company estimates that it has room for approximately 2,300 locations in the United States.
What you need to know
Young and dynamic fast casual restaurants such as Shake Shack, Zoe's Kitchen, and El Pollo Loco have many things in common. They can be riskier and more volatile than the big industry players. On the other hand, they are also delivering delicious performance, and they still offer enormous room for expansion in the years ahead.
For investors who have an above average risk tolerance and are looking for high growth opportunities, picking one of these restaurants from the menu could be an appetizing choice.