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I do not like The Crazy Chicken, aka El Pollo Loco (NASDAQ: LOCO). I don’t like the food, which doesn’t distinguish itself among its competitors. I don’t like the restaurants, which I find to usually be dirty and in lousy neighborhoods.
El Pollo Loco’s initial public offering – completed in July 2014 – seemed like a terrible idea that would rope in a lot of naive investors. It has. The stock is down more than 50% from its high.
El Pollo Loco earnings for the second quarter were released after Thursday’s closing bell. The results are telling, because they are everything a restaurant doesn’t want to see. The stock plummeted 14% in after-hours trading.
Crazy Bad Numbers
Company-operated restaurants saw a slight quarterly sales increase of 2.7% to $84 million, which was up just slightly over last year’s $81 million. If you stopped there, you’d be missing really important information – that this increase was basically the result of the company adding 13 new locations.
Investors must examine the same-store comparable sales to determine if sales growth is actually happening at an organic level. What we discover is something both interesting and disheartening.
El Pollo Loco earnings showed a 0.5% decline in same-store sales, and that was due to a 4% decrease in foot traffic. That means people are literally voting with their feet to eat elsewhere. If not for a 3.4% increase in the average check, those same store comps would have been worse.
However, for some strange reason, franchised stores did better, with revenue up 6% to $5.9 million. However, comparable sales went up by 2.6%.
How is it that franchised stores can do better than company stores? Some of it may truly be due to the location of these stores. Some locations are better for fast food than others.
However, it may also indicate that franchisees know how to run their businesses better than the company knows how to run its own. That can be indicative of a difference of opinion in company vision, and in execution as a result.
Remember, a franchisee has much more at stake than a company store. That franchisee has probably put all his money into buying that store, and drawn down debt. He’s going to work that store as best he can. A company store doesn’t have the same incentive.
There are 174 company stores and 244 franchises. Were I an investor in the stock, I’d be annoyed that franchises are doing better than company stores. That’s because, as a shareholder, I only enjoy a royalty payment from the franchise. I do not get their bottom line consolidated into the parent. I don’t enjoy their success!
Questionable Valuation
Valuation has finally come down to a reasonable level, although I still feel the stock is overvalued. With pro-forma net income up 21.4% to $7.4 million, or $0.19 per share, and the company on target to deliver $0.70 per share in fiscal year 2015, the stock is not necessarily insanely valued any more. It trades at a forward price-earnings ratio of 22.5, based on after-hours trading at $15.75 per share, on a 29% estimated increase over last year’s EPS.
Each store is now valued by the market at $1.43 million. That’s reasonable, compared to McDonald’s (NYSE: MCD), which is also a reasonable $2.5 million, and Shake Shack (NYSE: SHAK) at an outrageous $37.5 million.
So growth rate is in line with the P/E ratio. But there are problems.
First, revenues and same-store sales are going in the wrong direction.
Second, chicken is a commodity-driven business, both in terms of there being many chicken restaurants, and because chicken prices are subject to volatility.
I think El Pollo Loco is not something investors should get involved with. There are much better restaurants to look at.
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