3 Reasons Why Zoe's Kitchen Stock Will Bounce Back

By Markets Fool.com

Image source: Zoe's Kitchen.

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Like bad feta or moldy hummus, yesterday's stock action onZoe's Kitchen (NYSE: ZOES)was difficult to stomach. Shares of the fast-growing chain of Mediterranean restaurants plunged 17% following mixed quarterly results and a slight revision to its guidance. The financial shortfalls may seem subtle given the magnitude of the stock's drop, but this is the summer that the term "restaurant recession" has started to gain traction.

Poor chains are faring terribly, and even the great ones are clocking in with simply good results. The latter category explains Zoe's Kitchen's latest quarter and why a company that has historically been great in its brief public tenure was simply good this time around.

A stock hit is warranted. That's what happens when you fail to live up to lofty expectations and your valuation is equally lofty. However, let's go into why that 17% plunge yesterday was overdone and why it wouldn't be a surprise if Zoe's Kitchen made it all back before the end of the year.

1. Comps are holding up great

Revenue climbed 22% in Zoe's Kitchen's second quarter, a combination of new openings and a 4% uptick in comparable-restaurant sales. That may be off the torrid pace of the past. Comps moved 8.1% higher in the first quarter or the 6.3% spike in comps it produced for all of last year.

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This is still an impressive feat in this dicey climate. Zoe's Kitchen is a darling of the fast-casual niche that is dominated by burrito rollers, quick-bake pizza makers, and sandwich shops. Zoe's Kitchen and its Mediterranean spin on cuisine stand out in the fast-casual crowd, but it's still a better place for investors to be than fast food on one end and casual dining on the other.

Folks aren't dining out the way they used to, and now even Zoe's peer group is feeling the pinch. NPD Group's data shows that visits to fast-casual chains posted a year-over-year decline for the first time since the niche started to be tracked in 2004. Restaurants in general also posted a decline in comparable-restaurant sales. Just chiming in with positive comps is an achievement. Zoe's Kitchen at 4% makes it a rock star.

2. Reversing the reversal

It's never a good sign when a company hoses down its forecast. Zoe's warned on Monday afternoon that comps, revenue, and restaurant contribution margin would be slightly less than it was expecting for all of 2016 back in May. That may be true, but the story that isn't being said is that Zoe's was bumping its guidance higher following its first quarter. Let's go back six months to see how its new guidance holds up to where it was when the year began.

Metric Q4 Q1 Q2
Revenue (in millions) $275-$280 $277-$281 $277-$280
Comps for 2016 4%-5.5% 4.5%-6% 4%-5%
Contribution margin 20.3%-20.8% 20.5%-21% 20.5%-20.8%

Data source: Zoe's earnings releases.

You may notice that things aren't all that different than they were six months ago. The low end of the revenue and contribution margin are now slightly higher. The high end of the comps range is slightly lower. The other three bands are intact.

The stock closed at $29.31 the day after that report. It's marginally higher at $30.84 now. The refreshed outlook takes us essentially back to where we were six months ago with those expectations, but the company is larger and six months more down the line. A mere 5% stock uptick in that time is too low, especially when the S&P 500 is trading 14% higher. Zoe's is back to where it was six months ago -- only not as expensive.

3. There will be a race to quality

Investors are scurrying out of many restaurant stocks. It's instinctive. When you hear that escalating labor costs are forcing restaurants to inch prices higher at a time when grocery store costs for food are going the other way, it doesn't make going out for a meal such a savory value proposition.

The same scene won't play out with the actual restaurants. We still see traffic and checks growing at Zoe's Kitchen. We see the concept expanding, as it ownsall but three of its 186 locations with plans to open as many as 36 new restaurants this year.

It's the near-term mind-set that's bad. It's the the knee-jerk selling reaction that's moldy. Folks will be back for the feta and the hummus. Investors will be back for the stock.

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Rick Munarriz owns shares of Zoe's Kitchen. The Motley Fool owns shares of and recommends Zoe's Kitchen. 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.