Zoe's Illustrates How Tough It Is to Cut It in Restaurant Sector

 | Mar 03, 2017 | 9:00 AM EST
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Stock quotes in this article:

blmn

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mcd

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yum

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cmg

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dri

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dpz

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zoes

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cosiq

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plki

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qsr

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shak

Our local Bonefish Grill, owned by Bloomin' Brands (BLMN) , is a sight to behold, especially over a plate of Bang Bang Shrimp, currently my favorite appetizer. The restaurant always is crowded and there are typically lots of customers waiting for tables. The same may true of many restaurants these days, but that does not always translate into favorable stock prices or valuations.

Indeed, restaurants in general continue to face headwinds that include intense competition and increasing labor and input costs that are eating into margins (pun intended). With the S&P 500 up 7% year to date and investors excited as the Dow Jones Industrial Average hits new records, many restaurant stocks are not participating in the Trump rally.

The Big Five -- consisting of McDonalds (MCD) , up 6%; Yum Brands (YUM) , up 3.4%; Chipotle (CMG) , down 10.3%; Darden (DRI) , up 4.5%; and Domino's Pizza (DPZ) , up19% -- is up an average of 8.6% and doing better than most.

Then you see what has happened to a newer name such as Zoe's Kitchen (ZOES) , one of the more exciting and original recent restaurant concepts in recent years, and it puts the sector in perspective. Down 27% year to date and 54% over the past year, Zoe's stock is trading at all-time lows after the company reported a somewhat mild fourth-quarter earnings miss last week. Earnings per share -- actually, a loss of seven cents -- missed by a penny, while revenue of $61.98 million, though up 17.6% year over year, missed by $700,000. But same-store sales were up just 0.7%, well below the 1.2% consensus, and revenue guidance for 2017 of $325 million to $327 million was below the $329 million consensus.

Zoe's opened 38 restaurants in 2016 and expects to add another 38 to 40 this year. Both numbers are significant for a chain that now has 150 locations. However, growth investors are fleeing, unhappy with the company's progress, and the stock is paying the price.

Despite the pullback, Zoe's still is priced for growth. Zoe's is just marginally profitable at this point, and consensus earnings estimates for 2018 of 12 cents a share put the forward price/earnings ratio at 145. That isn't uncommon for an emerging name with high growth expectations, but is demonstrative of the premium investors pay for expected growth, and that's after the stock already has taken a 50% haircut.

ZOES has been on my radar for quite some time; we've been frequent visitors to our local store since it replaced a Cosi (COSIQ) a few years back. I just have not been able to bring myself to take a position yet. Longer term, this chain has a shot to be a huge success, but the execution is critical, and the stock likely will continue to be volatile. I think there may be an opportunity to get it cheaper at some point.

Overall, the five dozen or so publicly traded restaurant names that I track, without regard to size, are down an average of close to 2% year to date. The winner so far is Popeyes Louisiana Kitchen (PLKI) , up 31%, which Burger King parent Restaurant Brands International (QSR) recently agreed to acquire. The other major newcomer/growth story in the group, cult stock Shake Shack (SHAK) , is down about 2%. It trades at a lofty 54x 2018 consensus estimates -- still quite the phenomenon, still way too rich for my blood.

The restaurant industry is clearly facing its share of challenges, with many names struggling in an up market. I wonder what the carnage might look like in a pullback.

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