Will the Menu at Zoe's Kitchen Inc Deliver Growth in 2015?

By Markets Fool.com

"If it wasn't food 100 years ago, it isn't food today."
--Zoe's Kitchen founder Zoe Cassimus

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If you're a restaurant industry investor, you've undoubtedly noticed that momentum is building in the "fast-casual" segment. According to food industry research and consulting firm Technomic, while full-service restaurants increased sales at a rate of 2.5% in 2014, and quick-service restaurants improved by 2.3%, the fast-casual sector expanded more than four times as fast, at a blistering pace -- in this industry -- of 10.8%.

While as in years past, fast-casual star Chipotle Mexican Grill drew interest to the sector in 2014, by the end of the year, burger chains garnered most of the attention. The successful IPO of The Habit Restaurants whetted appetites for new burger investments. Shake Shack's recently announced IPO, which potentially values the chain at $1 billion, has ratcheted enthusiasm further. And fast growing, Denver-based Smashburger has made no secret of its desire to also potentially undertake an offering on the public markets.

As these popular burger joints gird to battle not only each other, but also established chains including Five Guys Burgers and Fries and Red Robin Gourmet Burgers, as well as a wounded quick-serviceMcDonald's looking for its lost market share, we can safely assume that the fast-casual burger business is about to become brutally competitive.

Thus, in the near future, the Mediterranean-inspired, health-conscious menu at recently publicZoe's Kitchen Incmay be a positioning blessing. Zoe's menu features familiar staples including hummus, kabobs, and vegetable platters, as well as its own interpretations of Mediterranean cuisine such as Chicken & Orzo Soup, and Greek Chicken Marinara. True to founder Zoe Cassimus' quote at the outset of this article, the restaurant has also launched a popular salad based on the ancient grain Quinoa.

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Source: Zoe's Kitchen

Zoe's has around 130 locations in its system, and plans to double its locations over the next four years.For now, the company has the relative luxury of planning expansion in a category without a dominant player. Although FastCasual.com recently ranked Zoe's, 10-unit Luna Grill, and 28-unit Garbanzo Mediterranean Grill as numbers eight, six, and 11, respectively, in its 2014 "Top 100 Fast Casual Movers" list, each of these three organizations is a tiny player in a very young food subset.In Mediterranean cuisine, no reigning behemoth such as a McDonald's or Chipotle exists for entrants to compete against.

Thus, Zoe's can experiment with its brand, tinker with its decor, and innovate its menu in a relatively safe space. Within the metropolitan markets set for its expansion, Zoe's will fill a niche position, offering itself as an alternative to the profusion of burger purveyors, not to mention Mexican, pizza, and Asian chains we'll see in the coming years.

Does Zoe's business plan support its niche ambitions?

Source: Zoe's Kitchen

Of course, positioning isn't everything. Investors should assess whether Zoe's can capitalize on its competitive niche. The chain's management team lists three simple strategic focus areas as a formula for success. Quoting directly from Zoe's most recent quarterly filing, the organization intends to:

  • grow our restaurant base
  • increase our comparable restaurant sales; and
  • improve our margins and leverage infrastructure

Of these three points, store expansion is probably the most vital near-term objective. Zoe's reported 126 locations total as of Q3 2014, and projected at the time to have between 133 and 134 by year end. If it met the year-end projection, Zoe's 2014 total additions (including franchisees) would land at 30 or 31 restaurants. To double its base in the next four years, it would need to open at least this amount annually.

Regarding the second strategic goal, Zoe's comparable-store sales base was only 78 out of a total system of 126 stores during the last reported period. Zoe's includes stores open for 18 months or more in its comparable-stores sales base, and since the chain is growing rapidly, this metric will take some time to become truly useful.

Taking into account this numerical grain of salt, the company posted a comparable-store sales increase during the first nine months of 2014 of 6.3%.A promising opportunity exists to bolster this number. Fully, 30% of Zoe's meals are eaten outside its locations. Catering comprises 17% of total sales, and non-catering takeout averages between 13% and 15%. Customers clearly like Zoe's on the go, and devoting marketing and structural resources to non-premises sales may be an easy way to heighten the revenue of existing stores.

Finally, Zoe's management team recognizes that it will also need to improve margins as the store footprint expands. Through the first three reported quarters of 2014, the company posted an operating loss of $3.98 million, or 3% of total revenue of $131.3 million.This operating loss is due to higher expense related to its IPO in April of 2014. We can add back the major IPO expenses to get an idea of adjusted operational performance this year:

Reconciliation Q1-Q3 2014
Loss from operations ($4.0)
Equity compensation expense $6.2
Additional accounting expense $0.8
Other IPO expenses $1.2
Adjusted operating income $4.2

All dollar figures in millions. Author's calculations. Source: SEC Filings.

After removing IPO expenses, we see that Zoe's year-to-date operating income margin is 3.2%. For a point of comparison, fast casual leader Chipotle reported an operating margin of 17.2% in the first three quarters of 2014.Zoe's management has indicated that optimizing costs and achieving economies of scale in purchasing are two levers to widen operating margin.For this reason, we're likely to see development of Zoe's locations in areas nearly contiguous to its current geographical base, to concentrate the regional purchasing power of both company-operated stores and franchisees.

A niche menu, a cogent plan

Patient investors may want to add Zoe's to their watch screens and portfolios in 2015. The company has an avenue to quiet, unchallenged growth which is largely dependent on its own ability to execute. While other segments of the fast-casual industry will continue to grab headlines this year, Zoe's presents a potential Mediterranean sleeper of a stock pick for the longer term.

The article Will the Menu at Zoe's Kitchen Inc Deliver Growth in 2015? originally appeared on Fool.com.

Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Zoe's Kitchen. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. 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.