Zoe’s Kitchen, Inc. (ZOES) Memo

Company  Description  Zoe’s  Kitchen,  Inc.  is  a  casual  fast-­‐dining  Mediterranean  restaurant  chain  that  focuses  on  providing  its  customers  with  fresh,  wholesome,  homemade  food  along  with  an  unparalleled  in-­‐store  customer  experience.  Founded  in  1995  by  a  couple  in  Birmingham,  AL,  Zoe’s  does  its  best  to  combine  its  priority  of  fresh  food  with  its  roots  of  southern  hospitality.  Heading  into  2015,  Zoe’s  will  have  over  130  stores,  with  30-­‐32  planned  openings  in  2015.  They  are  currently  based  mostly  in  the  Sunbelt  of  the  United  States,  but  are  beginning  to  grow  into  the  Midwest  and  mid-­‐Atlantic  regions.    Thesis  /  Key  Points  Strong  and  Smart  Financial  Growth:  Since  going  public,  Zoe’s  Kitchen  has  shown  great  financial  growth.  They  used  the  proceeds  from  their   IPO  to  pay  off  their  debt  and  going  forward  will  only  grow  organically  using  their  cash  flows.  Since  the  April  2014  IPO,  they  have  kept  zero  debt  on  their  balance  sheet.  Store  growth  has  been  constant,  with  the  restaurant  count  more  than  doubling  since  2011.  In  the  three  quarters  since  the  IPO,  sales  growth  has  increased  by  no  less  than  48%  each  quarter  (year  over  year)  and  comparable  store  growth  has   increased   by   no   less   that   6%   each   quarter   (year   over   year).   The   average   store   breaks   even   in   about   12   weeks,   which   is   very  impressive  on  an  industry  standard,  proving  Zoe’s  has  a  cost-­‐efficient  model  that  allows  for  fast  growth.    Zoe’s  is  on  its  way  to  breaking  even  in  2015  as  earnings  continue  to  increase.  Over  the  past  year  they  faced  huge  SG&A  costs  related  to  their  IPO  and  equity-­‐based  compensation  that  came  with  it.  On  an  EBITDA  basis  the  company  is  doing  very  well,  with  consistent  growth  year  over  year.  The  costs  related  to  the  IPO  are  not  recurring  and  going  forward,  investors  shouldn’t  be  worried  about  such  high  SG&A  costs.    Management  has  said  that  they  plan  to  double  store  count  in  the  next  four  years.  In  2015,  they  plan  on  opening  30-­‐32  new  restaurants  mainly  around  existing  markets  but  with  a  few  in  new  markets,  specifically  Kansas  City.  The  Zoe’s  leadership  team  is  committed  to  smart  growth  and  rather  than  putting  a  store  where  there  may  be  very  little  knowledge  of  Zoe’s,  they  plan  to  expand  to  areas  where  they  can  capitalize  off  of  brand  awareness.    Economies  of  Scale:  Zoe’s   is  working  on  creating  an  economy  of  scale   through  owning  and  operating  all  of   their  stores.   In  2014,   they  acquired  2  of  their  8  franchised  stores,  and  hope  to  repurchase  the  remaining  6  in  the  coming  months.  Their  goal  is  to  create  efficiencies  through   increased  buyer  power.  On   their  earnings  calls,   they  have  mentioned   that   they  are   streamlining  almost  all  of   their  processes  across  the  country   in  order  to   increase  this  power.  They  are   leveraging  this  strength  not   just  with  commodity  prices,  but  also   in  areas  such  as  store  maintenance,  software,  and  security.  As  the  store  count  grows,  leadership  believes  the  synergy  will  only  increase  and  allow  them  to  grow  margins  even  more.    Unique  Competitive  Advantage:  Zoe’s  biggest   strength   is   their  business  model   that  gives   them  a  competitive  advantage.  Unlike  most  fast  casual  dining  restaurants,  Zoe’s  strives  to  be  a   lifestyle  brand  that   is   involved  in  all  aspects  of  their  customer’s   lives,  not   just  their  meals.  Because  of   this,   they  have  developed  an  extremely   loyal   customer  base   that   is  willing   to   recommend  Zoe’s   to   friends  and  pay  more  for  meals.  Management  reported  that  98%  of  first  time  customers  would  come  back,  94%  of  customers  would  recommend  Zoe’s  to  a  friend  and  the  average  amount  spent  at  a  Zoe’s  is  $9.57,  significantly  above  the  industry  average  of  $7.40.  These  statistics  prove  that  Zoe’s  does  a  great  job  of  pleasing  their  customers  and  ensuring  that  they  have  the  best  in-­‐store  experience  as  possible.    To  complement  the  in-­‐restaurant  dining  experience,  Zoe’s  does  many  things  to  keep  its  customer  base  involved  with  the  Mediterranean  lifestyle.  They  have  an  active  blog  about  staying  positive,  Mediterranean  recipes,  and  many  other  things  in  line  with  their  motto  of  “Love  Life,  Love  Zoe’s!”  They  also  recently  launched  a  campaign  called  “Live  Mediterranean”  where  they  encourage  customers  to  incorporate  the  Mediterranean  lifestyle   into  all  parts  of  their  day—not  just  meals.  There  is  an  entire  section  of  their  website  dedicated  just  to  this  campaign,  and   it  has  many  aspects   (such  as   recipes,  where   to   travel   in   the  region,  and  how  the  Mediterranean  culture  can  help  your  health)  that  all  end  up  connecting  the  customer  back  to  the  benefits  of  the  Zoe’s  menu.    Another  aspect  of  Zoe’s  competitive  advantage  is  their  knowledge  of  their  target  customer.  Zoe’s  targets  affluent,  educated  women  and  their  families,  and  they  do  many  things  to  attract  her  and  keep  her  as  a  customer.  A  young,  educated  and  affluent  woman  will  probably  be  a  working  mom,  so  Zoe’s  has  created  a  solution  for  her  called  “Mediterranean  Meals  on  the  Go”.  This  product  is  meant  to  feed  3-­‐6  people  for  under  $40  and   is  perfect   for  working  mothers  who  may  not  have  time  to  cook  but  still  want  to  provide  their   family  with  a  healthy  meal.  They  have  also  partnered  the   initiative  with   the  hashtag  #ZoesTableTalk  where  moms  are  encouraged  to   film  their  kids  asking  them  questions  such  as  “What  makes  you  most  happy?”  or  “What  was  the  best  part  of  your  day?”  and  then  post  the  results  on  Facebook/Instagram  with  the  hashtag.  This  gives  moms  a  chance  to  show  off  their  cute  kids  but  also  stay  positive  and  “Love  Life”  as  the  Zoe’s  motto  says.    Zoe’s   Kitchen   is   also   very   good   at   keeping   up   with   consumer   trends   and   fits   right   in   with   current   consumer   sentiments.   Most   US  consumers  today  want  to  live  a  healthy  lifestyle  but  may  not  have  a  ton  of  disposable  income  to  spend  on  expensive  food.  Zoe’s  offers  them  the  chance  to  still   live  healthy  but  not  spend  too  much  each  meal.  They  advertise   the   fact   that  everything  they  make   is  cooked  from  scratch,  all  of  their  products  are  fresh  and  organic,  and  they  want  all  of  their  customers  to  have  a  “wholesome”  experience.  All  of  these  things  also  line  up  with  current  consumer  trends  of  organic,  healthy  living  and  eating.    Lastly,  Zoe’s  is  unparalleled  in  its  customer  service,  especially  when  compared  to  other  casual  fast-­‐dining  restaurants.  They  truly  embody  their   southern   roots   and   strive   to  be  extremely  pleasant   and   caring   towards   every   single   customer.  Management   even   said   they   see  customers  as  part  of  the  Zoe’s  family  and  they  make  sure  that  all  of  their  team  members  believe  the  same.    Strong  Industry  Growth:  The  casual  fast-­‐dining  segment  is  one  of  the  fastest  growing  in  the  restaurant  industry,  with  a  10%  CAGR  and  a  

Name:  Selena  Kowalski   Phone  #:  847-­‐714-­‐4979   College/School:  Commerce   Year:  3rd  

Zoe’s Kitchen, Inc. (ZOES) Memo projected  worth  of  $50B  by  2017.  Zoe’s  is  poised  to  take  advantage  of  this  growth  as  customers  want  affordable,  healthy  options  but  do  not  have  the  time  for  a  typical  sit-­‐down  restaurant  or  to  cook  their  own  meals.    

Misperception  Competition  is  extreme:  Many  people  are  turned  off  of  Zoe’s  and  the  entire  casual  fast-­‐dining  segment  because  they  are  convinced  it  is  crowded  and  thus  hard  to  differentiate  oneself.  This  is  true  for  many  restaurants,  but  as  described  above,  Zoe’s  has  an  extremely  unique  competitive  advantage  in  this  marketplace.  It  is  one  of  the  only  (if  not  the  only)  Mediterranean  restaurant  in  this  segment,  and  it  is  the  only  one  focused  on  being  extremely  healthy,  wholesome,  and  most  importantly,  a  lifestyle  brand.  No  other  restaurant  chains  are  trying  to  integrate  themselves  into  the  daily  lives  of  customers,  and  this  is  where  Zoe’s  has  an  advantage  in  a  competitive  industry.  It  has  a  loyal  customer  base  that  loves  to  be  involved  in  the  Zoe’s  community,  and  that  is  unique  to  the  Zoe’s  brand.    “But  it  doesn’t  make  money”:  Many  investors  are  also  concerned  that  Zoe’s  has  not  posted  a  profit  yet,  however,  they  are  failing  to  see  the  tremendous  organic  growth  that  has  been  occurring.  As  mentioned  above,  Zoe’s   is  using  their  own  cash  flows  to  generate  growth  and  is  still  trying  to  recover  from  one-­‐time  costs.  Like  any  other  growth  company,  they  are  spending  a  lot  and  fast,  but  their  customer  base  is  solid  and  they  are  well  on  track  to  break  even.    VAR  Customer   Service:   I   talked   to   the  manager   of   the   Charlottesville   Zoe’s   store   about   their   employee   training   program   and   how   Zoe’s  encourages  the  mantra  of  “Mediterranean  food  with  southern  hospitality”.  She  said  that  corporate  puts  the  employees,  and  especially  the  managers,  through  extensive  training  programs.  They  are  told  that  they  are  the  faces  of  the  organizations  and  usually  the  only  point  of  contact  the  customers  will  have  with  the  company,  so  it  has  to  be  as  pleasant  and  enjoyable  as  possible.  When  I  asked  her  about  the  Sothern  Hospitality  aspect  of  the  firm’s  culture,  she  said  it  is  very  apparent  not  only  in  training  but  also  in  the  firm’s  management.  They  are  all  very  southern  and  very  polite  to  everyone  in  the  organization.  Employees  are  told  to  be  as  polite  and  patient  with  customers  as  possible  and  to  do  their  absolute  best  to  satisfy  their  requests.    Brand  Perception:  In  a  survey  of  just  under  100  people,  70%  said  they  had  been  to  Zoe’s  kitchen  and  96%  had  heard  of  it.  When  asked  why  they  did  or  didn’t  like  Zoe’s,  they  responses  where  overwhelmingly  positive.  The  only  complaints  were  prices  that  may  be  a  bit  “too  high”  for  their  college  budget,  but  they  wish  they  could  afford  to  go  there  more.  On  the  flip  side,  many  more  people  said  that  for  the  quality   of   the   food,   the   prices   are   extremely   reasonable.   There   were   also   many   positive   comments   about   the   service   and   the  Mediterranean  theme.    How  It  Plays  Out  Zoe’s  Kitchen  should  continue  to  grow  in  terms  of  store  growth  and  comparable  stores  sales.  With  this  continued  growth  and  increased  cash  flow,  they  should  continue  to  organically  expand  their  restaurants   into  different  areas  of  the  country  and  thus  gathering  an  even  larger   customer   base.   As   the  move   into   larger  metropolitan   areas   such   as  New   York,   Chicago   and   especially   cities   in   California,   they  should   have   heightened   brand   awareness   to   aid   their   competitive   advantage   of   being   a   lifestyle   company   that   truly   understands   its  customers.  The  company  is  smart  and  should  continue  to  develop  new  programs  to  increase  and  retain  their  customer  base,  with  smart  campaigns  on  social  media  and  in-­‐store.  In  a  few  years,  Zoe’s  should  be  a  national  (or  possibly  international)  restaurant  chain  that  has  a  name  as  familiar  as  Chipotle.    If  bought,  MII  should  consider  exiting  the  position  when  the  market  seems  saturated  with  Zoe’s  Kitchen  stores  and  the  brand  is  known  amongst  most   consumers.   This   can  be  determined  by   number   of   stores   and   the   regions   in  which   Zoe’s   operates.  We   should   also   be  careful  of  the  stock  being  overpriced  and/or  competition  in  the  segment  heating  up  in  current  regions  or  regions  in  which  Zoe’s  hopes  to  expand.    Risks  /  What  Signs  Would  Indicate  We  Are  Wrong?  Commodity  prices:  Zoe’s  is  exposed  to  changes  in  commodity  prices  that  are  needed  for  its  operations  such  as  poultry,  certain  fruits  and  vegetables,   and   labor.   Their  margins   could  be   affected  by   fluctuations   in   these  prices,   but  management  has  made   clear   that   as   their  economy  of  scale  grows,  they  will  become  more  and  more  insulated  to  major  price  changes.  Additionally,  Zoe’s  customers  have  already  proven  that  they  are  willing  to  pay  a  premium  for  Zoe’s  products.    Competition:  The  casual  fast-­‐dining  segment  is  extremely  competitive  and  there  is  a  change  that  other  companies  could  decrease  Zoe’s  chance  for  success  going  forward.  One  of  the  biggest  threats  is  that  another  Mediterranean  food  company  opens  stores  in  areas  of  the  country  where  Zoe’s  plans  to  go  in  the  future.  This  would  make  it  much  harder  for  Zoe’s  to  penetrate  that  market.  However,  because  of  the  extremely  loyal  customer  base,  it  is  hard  to  believe  that  Zoe’s  wouldn’t  do  well  wherever  it  opens  a  store.    When   following   the   stock,  MII  would   know   the   thesis   points   are   incorrect   if   the   company   struggles   to   break   even,  margins   are   hurt  severely,  the  customer  base/brand  equity  starts  to  erode  or  comparable  stores  growth  slows  or  goes  negative.  These  would  all  be  signs  that  Zoe’s  is  not  as  successful  as  we  thought  it  could  be.    Signposts  /  Follow-­‐Up  Metrics  to  follow:  

• Comparable  store  sales  • Store  openings  • Sales  growth  • Gross  and  Operating  margins  • EBITDA  growth  

Important  Company  Financial  Data  (as  of  11/30/14)  Current  Price:  31.63  Market  Cap:  581.7  million  52  Week  Range:  23.73-­‐38.42  EPS:  -­‐0.73  Revenue:  160.4  Million  Price/Book:  4.94  

 

Zoe’s Kitchen, Inc. (ZOES) Memo    Exhibit  1:  Stock  performance  since  Initial  Public  Offering  in  April  2014  

         Exhibit  2:  EBITDA  and  EBITDA  Growth  (dollars  in  thousands)    

Apr-14 Apr-13 % Change

3,847 2,700 142%

Jul-14 Jul-13 % Change

4,713 3,270 126%

Oct-14 Oct-13 % Change

4,651 3,657 127%  Exhibit  3:  Restaurant  Growth      

 

Zoe’s Kitchen, Inc. (ZOES) Memo  Exhibit  4:  AUV  Growth    

 Exhibit  5:  Equity  to  Number  of  Stores  Comparison  in  the  Casual  Fast-­‐Dining  Segment        

Equity per Store Market Cap Stores Equity/Store Chipotle 20,580,000,000 1,600 12,862,500

Noodles & Co. 729,230,000 340 2,144,794

Panera Bread 4,470,000,000 1,800 2,483,333

Potbelly 381,760,000 300 1,272,533

Zoe's Kitchen 581,700,000 130 4,474,615    Exhibit  6:  Zoe’s  Kitchen  Locations  (as  of  February  2014)    

 

Zoe’s Kitchen, Inc. (ZOES) Memo    Exhibit  7:  “Live  Mediterranean”  Campaign    

                                                   

                                                                                   Exhibit  8:  #ZoesTableTalk  Campaign    

       

Zoe’s Kitchen, Inc. (ZOES) Memo  Ideas  for  the  Club    Over  the  past  year,  and  especially  over  the  past  semester,  I  believe  MII  has  done  some  great  things  and  made  tremendous  improvement.  I  love  that  we  are  taking  steps  to  ensure  that  the  club  is  made  up  of  members  who  are  passionate  not  only  about  investing  but  also  the  club  and  making  a  difference  in  it.  By  “forcing”  people  to  be  on  associate  teams  and  submit  a  memo,  I  think  we  are  going  to  ensure  that  the  members  next  semester  are  more  dedicated  than  ever  before.  However,  I  think  we  need  to  continue  making  steps  to  enhance  the  member’s  experiences  so  that  they  will  be  just  as  passionate  about  the  club  as  we  are.  Based  on  what  I’ve  heard  from  members,  I  think  the  first  thing  we  need  to  do  is  more  clearly  define  the  role  of  Associates.  By  requiring  that  everyone  be  on  an  associate  team,  we  greatly  increased  the  responsibilities  of  the  associates  but  almost  forgot  to  remind  them  of  it.  I  think  starting  next  semester  we  must  sit  them  all  down  and  tell  them  that  in  this  new  structure,  their  role  is  no  longer  to  just  submit  memos,  it  is  to  generate  ideas  and  most  importantly,  to  mentor  a  group  of  8  or  so  members.  I  think  we  definitely  took  a  step  in  the  right  direction  by  requiring  that  members  be  on  teams,  but  we  failed  in  terms  of  making  sure  the  teams  were  a  good  experience  for  everyone.  Going  forward  we  need  to  have  constant  check-­‐ins  with  the  associates,  asking  how  their  members  are  doing,  what  sorts  of  work  they’ve  been  doing,  etc.  I  also  think  as  managers  we  could  host  workshops  or  events  and  invite  2  or  3  associate  teams  to  them.  That  way  people  get  to  know  each  other,  we  get  to  know  the  various  associates  and  teams,  and  we  can  ensure  that  analysts  are  learning  a  lot  from  their  experience  on  an  associate  team.  I  think  the  structure  we  set  up  is  really  great  and  has  a  lot  of  potential,  we  just  need  to  continue  to  work  with  it  until  it’s  perfect  and  even  the  new  members  feel  like  they  are  truly  contributing  to  the  club.      I’ve  been  saying  this  for  forever,  but  I  also  really  think  that  we  need  to  have  a  much  more  structured  education  system.  People  come  into  MII  because  they  want  to  learn  and  we  are  failing  if  we  don’t  teach  them.  What  we  have  isn’t  good  enough  and  throwing  together  a  PowerPoint  the  night  before  the  meeting  isn’t  good  enough  either.  I  really  think  we  all  need  to  sit  down  and  outline  a  plan  for  a  logical  order  in  which  to  teach  topics,  what  we  should  teach  older  vs.  younger  members,  etc.  It  may  have  to  happen  over  the  summer,  but  if  we  put  in  effort  once,  we’ll  never  have  to  do  it  again  and  the  future  management  teams  can  use  what  we  made  for  them.  If  we  succeed  in  doing  this,  our  members  will  be  much  happier  because  they  will  be  learning  (which  is  ultimately  why  they  joined  MII)  and  I’d  bet  that  our  portfolio  would  improve  as  well  because  we  would  have  an  army  of  educated  members  submitting  ideas  to  us  each  semester.      I  also  think  that  we  can  better  use  our  meeting  times  to  do  things  that  are  beneficial  to  everyone.  After  talking  to  various  members,  people  want  to  have  more  group  activities  and  discussions  during  regular  meeting  time.  We  could  have  managers  leading  various  discussions  about  news  topics,  industries,  etc,  and  it  would  give  members  a  place  to  voice  opinions  in  a  smaller  and  less  intimidating  setting.  A  problem  I  heard  from  many  members  was  that  they  felt  like  they  had  nothing  to  contribute  to  the  large  group  because  they  felt  like  everyone  was  smarter  than  them  and  they  were  very  intimidated.  If  we  conduct  small-­‐group  activities  during  normal  meeting  times  (they  could  literally  be  anything:  each  group  takes  a  stock  in  our  portfolio  and  discusses  it,  people  split  up  and  are  walked  through  a  DCF,  etc),  members  would  be  much  more  likely  to  participate.  It  almost  doesn’t  matter  what  the  activity  is  as  long  as  it  involves  a  smaller  setting  in  which  they  can  voice  their  opinions.  People  hate  it  when  they  feel  like  they  can’t  contribute,  because  they  feel  useless.  Let’s  not  make  our  members  feel  useless.      I  think  there  are  also  a  lot  of  little  things  we  can  do  to  enhance  the  member  experience  that  wouldn’t  take  much  on  our  part,  but  could  mean  a  ton  to  our  members.  For  instance,  we  could  do  manager  office  hours  (set  up  in  a  way  that  members  would  actually  come),  or  have  an  accounting  review  session  before  the  final  or  midterms  (s/o  to  COMM  2010,  everyone’s  favorite  class),  or  older  managers  could  do  mock  interviews  with  members.  There’s  so  much  we  could  do  that  members  would  love,  and  it  would  also  offer  them  yet  another  small  group  setting  to  get  to  know  one  another.      Additionally,  I  am  excited  to  continue  discussions  with  all  the  women  in  the  club,  and  hopefully  grow  it  into  a  really  cool  network  by  the  time  I  leave.  I  think  it  can  be  something  really  great,  where  the  girls  in  the  club  can  find  (yet  another)  small  group  setting  in  which  to  find  friends,  mentors,  and  support.  I  hope  to  continue  to  have  discussions  with  them  at  least  once  a  month,  set  up  a  Facebook  group  in  which  they  can  share  ideas/news  or  sign  up  to  pitch  together,  and  possibly  set  up  an  event  with  Dean  Leonard  to  come  chat  with  them  and  talk  a  little  about  women  in  business.