Takeaway: They continue to prove that they are some of the best operators in the industry.
ZOES in on the HEDGEYE Best Ideas list as a LONG
ZOES delivered a fantastic quarter, exceeding our already bullish expectations. The company beat on nearly every metric, driven by same-store sales, climbing to 7.7% beating consensus by 180 basis points (traffic was up 3.7%). Coupled by top ($63mm vs. consensus $61.4mm) and bottom line beats ($0.7mm vs. consensus -$0.1mm), there was nothing to complain about in this one.
Management increased its full-year 2015 guidance, including higher 2015 revenues of ($218mm to $223mm vs. prior $215mm to $220mm) and vs. consensus $219.9mm. The higher revenues growth is driven by high-quality 2015 comps of 4.0% to 6.0% vs. consensus +5.1%, but which now incorporates no new pricing in 2H15. Management also guided to higher restaurant contribution margins of 20.0% to 20.5% vs. 19.7% to 20.2% and new 2015 new store development of 31 to 33 vs 30 to 33.
As shown in the table below, they are effectively growing there business, while intelligently managing cost line items, to maintain a healthy company.
Same-Store Sales Composition
Same-store sales increased 7.7% during Q1 FY15, consisting of a 3.7% increase in traffic, a 2.8% increase in product mix and a 1.2% increase in price. Since the price increases were taken last year, that consideration will go away this July, leading to management aiming for 4-6% comp sales growth for FY15. The two biggest contributors to mix were catering and new flavors of hummus.
We came out of this earnings report being very positive about management doing all the little things right. They continue to prove that they are some of the best operators in the industry. Importantly, many small cap restaurant companies with an undisciplined unit growth strategy experience significant labor inefficiencies as they expand. ZOES is in a different class of companies. In a quarter where ZOES opened 12 new company-owned restaurants they managed to decrease both COGS and labor.
COGS were down 140 basis points, primarily driven by new annual pricing agreements for produce, feta cheese and olive oil. Although some of these Q1 savings will be partially offset by rising chicken prices (which have increased in Q2 by 15% sequentially since Q1). The company is projecting full year COGS to be slightly above 32% which would be flat relative to last year. This is virtually unrelated to avian flu, per or thought leader call, only 1% of chickens used for their meat have been infected. Additionally, eggs represent roughly 1% of COGS, making those price increases insignificant.
Labor costs are obviously a growing concern around the country but ZOES has been methodical about this cost line. They track labor on a daily basis, run labor matrices, and have become much more efficient at opening stores. They expect this number to increase slightly as they have added an additional manager at seven high volume locations, to build out the bench of managers to enable future growth. This extra cost now will pay off greatly in the future.
ZOES was added to our Best Ideas list as a long on 4/02/15, admittedly since then the stock hasn’t moved up much, just about 3.8% but the underlying thesis is being confirmed.
LTM Stock Price Performance
We still like ZOES on the long side for many reasons, including its:
- Superior brand positioning
- Management philosophy and execution
- Unit opening geographic profile
- Early-stage average unit volumes and returns
We want to close this note with a quote from the CEO that describes the basis for our bullish stance. “Zoës is a differentiated concept offering wholesome, freshly prepared Mediterranean dishes with Southern hospitality, appealing to guests across the country and inspiring them to live Mediterranean. We continue to bring this Mediterranean lifestyle to more guests, opening 12 new restaurants in the first quarter, and we remain on track to open 31 to 33 new restaurants in 2015. We are confident that we can successfully operate over 1,600 units in the US long term.” This is the most differentiated offering in the quick service segment, and this team knows how to take advantage of that.
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Takeaway: Tops are processes & “late-cycle” is not some discrete peak on a Macro sine curve. Move while the music plays but don't be willfully blind.
A CENTURY OF CYCLES: In our 2Q15 Macro Themes presentation we profiled the historical economic cycles of the last century, catalogued a selection of late-cycle indicators and contextualized the current expansion within the historical experience.
Canonical Macro cycles, left to themselves (i.e. with central banks following a largely passive policy reaction function), follow a pattern that largely resembles the circular, counter-clockwise flow captured in the inflation-output loop depicted in the chart below.
Conventional monetary policy is designed to function within the context of this naturally evolving cycle. The broader goal of current policy efforts is to both jump-start and (perhaps discordantly) smooth such a cycle in the face of persistent cyclical challenges and sectoral/secular shiftings.
“PATIENCE” - TOPS ARE PROCESSES: The halcyonic days of the late-cycle invariably birth discussion about whether it is, in fact, different this time, whether the economic cycle actually matters to stocks over protracted, investible periods of time and whether great central-bank catalyzed volatility moderations can matriculate into perma-profiteering opportunities.
The “It’s different” tag-line holds credence to the extent it refers to using the temporal pattern of typical business cycle oscillations as the appropriate anolog for the current expansion. Indeed, a defining characteristic of financial/balance sheet crises is the muted and crawling pace of the subsequent recovery. ‘Lower in Amplitude and Longer in Period’ is the periodic function speak we’ve used to describe the likely macro path over the last 2 years.
As it stands, we’re now 73-months into the current expansion – which compares to a mean of ~60 over both the last century and post-war era. What’s worth re-remembering is the fact that, on average, it takes between 6.5 and 8 years to reach pre-crisis levels of income following a financial crisis. In the current cycle - real per capita income in the U.S. reached pre-crisis levels at the end of 2013, so just about 6 years from the onset of the recession.
So, even with unprecedented intervention and global policy coordination we still fell basically right on the average. This time, in fact, was not particularly different.
PROFITS PAST-PEAK? As Keith referenced in an institutional highlight yesterday - during the 2000 and 2007 economic (and profit cycle) slow-downs, Wall St ramped M&A/IPO/Buyback activity to levels never seen before. I.e. the ramp in “everything is different” was happening to offset the cyclical slowdowns.
Corporate Profits peak mid-to-late cycle and the last few quarters of data suggest we’re probably past peak in the current cycle. Past peak profitability in combination with companies facing prospective acceleration in wage inflation, a continued dearth in aggregate global demand and the ongoing secular retreat in the worlds core consumption demographic of 35-54 year olds is not a factor cocktail supportive of a step function rise in capex.
VALUATION IS NOT A CATALYST…BUT IT IS A DECENT HARBINGER:
Valuation is not a catalyst and investor’s maintain varying proclivities for particular multiples and conceptual valuation frameworks. There is good debate to be had regarding the superiority or shortcoming of different multiples but there is a more general point to be made about current levels of valuation.
Looking across the selection of metrics below, broadly, current valuations are richer than pretty much at any point except the nose bleed tech bubble highs. Lower neutral policy rates and perma central bank interventionism may indeed be supportive of higher mean valuations but that only modestly dilutes the conclusion. When valuations are in the top decile of LT historical averages, subsequent returns over medium and longer-term periods are just not that compelling.
Solving for what drives prices higher as profits flag is trivial. But if you’re going to be paying near-peak multiples on peak margins as margins appear to be past peak and the expansion enters its twilight, you should at least be aware that that’s what you are doing.
Tops are processes and “late-cycle” is not some discrete peak on a Macro sine curve. We’re continuing to move tactically while the music plays but we won’t be willfully blind to the #LateCycle reality of it all.
Christian B. Drake
On Fox Business' Mornings with Maria today, Hedgeye CEO Keith McCullough discussed the U.S. economy, stagnant wage growth and how to rekindle economic growth with Laffer Associates Chairman and economist Art Laffer, host Maria Bartiromo and FBN's Sandra Smith.
The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.
LONG SIGNALS 80.64%
SHORT SIGNALS 78.61%