When the small, better-for-you restaurant chain Zoe's Kitchen (NYSE: ZOES) made its public debut back in 2014, the future looked bright. Fast-casual dining -- blending high quality fare with a quick and convenient setting -- was all the rage, and the chain's management had grand plans to become a nationwide powerhouse in Mediterranean cuisine. Things have not panned out that way, though.
In this segment from Industry Focus: Consumer Goods, Vincent Shen is joined by Motley Fool contributor Nicholas Rossolillo to talk about what went wrong and the events leading up to Zoe's go-private announcement.
A transcript follows the video.
10 stocks we like better than Zoe's KitchenWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Zoe's Kitchen wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 6, 2018
This video was recorded on Aug. 21, 2018.
Vincent Shen: A private equity firm, Brentwood Associates, they acquired a large stake in Zoe's back in 2007, when the chain operated less than 20 restaurants. By April 2014, when the stock debuted at $15 per share, Zoe's had expanded to over 110 locations. With that IPO, shares popped 65% on their first day of trading. Not too long after that, by mid-2016 -- about two years later -- the stock had nearly tripled from the IPO price to about $40 per share. At that time, Zoe's was still expanding to new markets. It was quickly approaching 200 restaurants. Management envisioned doubling the store base to 400 locations by 2020, with an ultimate goal of as many as 1,600 total locations.
But as quickly as the stock rallied, it was, again, another two years later -- 2018 now -- we have shares trading below $9. The current buyout price that was offered was just $12.75 per share. That's still good for a 33% premium over the last closing price before the deal announcement.
Nick, you've been following Zoe's for quite a few years. I'm curious what your take is, in terms of what happened and why the stark reversal, in terms of the restaurant's outlook in just that two years' time.
Nicholas Rossolillo: Right. A couple of things at play. Zoe's is expanding. Management has delivered on that initiative. They're up to 261 locations. That was per the announcement that they last made on Friday. A lot more stores than they had a few years ago, when they debuted as a public company.
But a lot of those new locations, Zoe's has kept in its home market. At 261 restaurants, it's still a pretty small chain. They're also a regional chain. Most of their locations are in the southeast quadrant of the United States, with just a handful outside of that area. As far west as they've made it is a few restaurants in Arizona, a few in Colorado. Rather than go nationwide with the concept, management chose to keep it in the Southeast. There's been some dispute over whether that has been a good idea, as maybe they've started to step on ...
Shen: Each other's toes, in terms of the store locations?
Rossolillo: Yeah, on these locations' toes. They're stealing sales from themselves, essentially.
Shen: What do you think about the rapid expansion pace? In just four or five years, they've essentially doubled their store base multiple times. With that, I know that management has spoken before, when they initially started running into weaker results, how the newer restaurants needed more time to develop their business, get their feet beneath them, so they could see strong results. But that doesn't seem to have panned out, right?
Rossolillo: No, not yet. Again, going back to this last report from Friday, Zoe's is still posting negative same-store growth, down 2.4% so far in 2018 compared with last year. That's on top of the 2% decline in 2017. Yeah, the existing stores are not doing well. In addition to that, management also said that they've identified 30 underperforming restaurants in the quarter that they're basically going to write off as a loss. They're never going to get their investment back in those locations. The company took a $16.3 million impairment charge in the second quarter.
Shen: Again, that speaks to the struggle we're seeing here across the restaurant industry, with the overexpansion here. The growth that Zoe's was seeing initially was really strong. It surprises me still how quickly results turned for the worse here. At the end of fiscal 2016, Zoe's reported its 28th consecutive quarter of comparable-store sales growth. Those comps had been slowing from high single-digit levels earlier in that year to below 1%. But then, from 2017 on, five out of six quarters have been negative for the comps. And this isn't a situation like Chipotle, where there's this obvious roadblock or catalyst for the decline in results. It was really these broad industry headwinds coming to play.
In terms of the stock itself, the decline that we've seen, that tends to happen when a stock rallies on really hot growth expectations. At its peak, Zoe's' stock was trading at over 350x earnings, plus very thin profitability.
Nicholas Rossolillo owns shares of Zoe's Kitchen. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Zoe's Kitchen. The Motley Fool has a disclosure policy.