3 Up-and-Coming Restaurant Stocks

By Markets Fool.com

The restaurant industry is famously challenging and competitive. However, it can also be deliciously profitable for restaurant companies serving a tasty menu to a hungry clientele. Shake-Shack , Papa John's International , and Zoe's Kitchen are three such restaurant stocks offering delicious potential for growth.

Continue Reading Below

Shake Shack

Shake Shack has a simple and effective customer proposition. The company serves mostly high-quality hamburgers, hot dogs, and shakes made with fresh and natural ingredients. Shake Shack operates in the fast-casual segment, which includes companies that keep the speed and convenience of traditional fast-food chains but offer superior products for a few extra dollars.Shake Shack is rapidly gaining traction among customers, especially when it comes to millennials and young consumers, a crucial demographic segment for the industry.

Image source: Shake Shack.

According to financial reports for the first quarter of 2016, this hamburger chain is on fire. Total revenue during the period amounted to $54.2 million, a succulent 43% year-over-year increase. Same-store sales grew 9.9%, and the company opened three new restaurants during the quarter. Profitability is also moving in the right direction. Restaurant-level operating margin jumped by 250 basis points, reaching 28.2% of revenue.

Shake Shack added the new Chicken Shack sandwich to the menu in January, and it was the biggest contributor to traffic growth during the quarter. The company recently opened its first restaurant in California. According to management, it was one of the strongest openings for the company in its 12-year history. This bodes well in terms of evaluating Shake Shack's potential for expansion going forward.

Continue Reading Below

There are only 47 domestic and company-operated Shake Shacks as of the end of the first quarter, in addition to 41 licensed units, 36 of them in international markets. This relatively small store base should allow plenty of room for expansion over the long term. In a sign of confidence, management recently raised its guidance for restaurant openings in 2016, from 13 to 16 new units.

Papa John's International

Papa John's International has 4,903 systemwide pizza restaurants as of the end of the first quarter, including 3,390 units in North America and 1,513 units overseas. Only 729 restaurants, all of them domestic, are company-owned. This highly franchised business model is quite efficient in terms of expansion, as it allows Papa John's to open new restaurants without bearing the cost of that expansion.

The company's slogan -- "Better Ingredients. Better Pizza" -- is quite clear when it comes to explaining its competitive strategy based on quality differentiation. Papa John's offers fresher and more natural ingredients than the competition; for example, the company uses unbleached flour made from its proprietary formula and fresh-packed tomato sauce as opposed to sauce reconstituted from tomato paste.

Image source: Papa John's

Systemwide comparable sales grew by a sluggish 0.1% in North America last quarter, but sales growth in international markets was a much stronger 5.7%. Importantly, management is doing a great job at keeping expenses under control, and share buybacks are reducing the amount of shares outstanding, allowing Papa John's to deliver a vigorous 25.5% increase in earnings per share during the period.

The company's development pipeline includes approximately 1,300 new restaurants, the majority of which are scheduled to open over the next six years. Papa John's is planning to open 1,100 units in international markets, versus only 200 restaurants in North America, so management is aggressively betting on international growth.

Zoe's Kitchen

Zoe's Kitchen operates in the fast-casual category. The company is focused on "Mediterranean-inspired dishes delivered with Southern hospitality." Like Shake Shack and Papa John's, Zoe's Kitchen offers fresh ingredients and superior quality over traditional restaurant chains, a winning proposition in the industry nowadays.

Total revenue during the first quarter of 2016 jumped 27.6% to $80.4 million. Same-store sales increased 8.1% on the back of a 6% increase in transactions and a 2.1% price increase, and Zoe's Kitchen opened 11 company-owned restaurants during the quarter. Restaurant-level contribution margin grew 29.4% to $17.7 million, amounting to 22% of restaurant sales.

Image source: Zoe's Kitchen.

The company introduced four new menu items last quarter -- the Mediterranean Baked Feta starter, Live Med Salad, Rosemary Ham Piadina, and Spinach and Mushroom Piadina. In addition, Zoe's Kitchen is expanding into catering, which, according to management, is a key driver of sales growth for the business.

As of April 18, there were 174 company-owned restaurants and three franchised units, all of them in the United States. Management is planning to open 34 to 36 new locations during 2016, and it believes it has enough room for nearly 1,600 domestic units over the long term. The company hasn't even tested the waters in international markets at this stage, so Zoe's Kitchen has enormous potential for expansion in the years ahead.

The article 3 Up-and-Coming Restaurant Stocks originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Zoe's Kitchen. The Motley Fool owns shares of Papa John's International. 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.