|Shares Out. (in M):||36||P/E||0.0x||0.0x|
|Market Cap (in $M):||1,389||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||168||EBIT||21||0|
As I was working on this today I noticed the discussion about LOCO under the Fiesta Restaurant Group idea and the concern over the lack of borrow. On Monday, August 4th option trading will begin in LOCO which will allow VIC members who can’t borrow the stock to establish a synthetic short in this name by selling calls or utilizing other option strategies to establish a short position.
LOCO has been on fire since its IPO last week, racing upward from its $15 IPO price to $38.75 at yesterday’s close, in just 5 trading sessions. LOCO has been trading so explosively partly due to hype-laden comparisons to CMG. However, I believe that former high-flying restaurant IPOs PBPB and NDLS are far better comparables for LOCO. Both PBPB and NDLS IPO’d with similar “the next CMG” hype to that which is currently being lavished upon LOCO and both traded at hysterical valuations out of the gates. But both ultimately came crashing to earth as the market ultimately realized what should have been obvious at the time of their IPOs- that both not only traded at ridiculous valuations, but both also lacked the type of robust growth trajectories demanded by those valuations.
I believe that LOCO likewise lacks the growth to justify its nosebleed valuation, and will ultimately suffer a similar fate.
Let’s start with the fact that this company has lost money for 7 consecutive years. LOCO made a small profit last quarter, but it has yet to prove that it can be profitable for a full year. In fact, the company lost twice as much money in 2013 as it did in 2012 (LOCO reported net losses of $16.9 million, $7.9 million, and $32.5 million for 2013, 2012, and 2011, respectively.) I don’t know specifically why last quarter was stronger than its recent subpar results (it’s not as if the company suddenly radically revamped its menu- it was selling the same chicken that it has been selling for years with poor results), but the fact that this “breakthrough” quarter occurred immediately prior to its IPO is certainly suspicious. If that quarter turns out to be a fluke, it would be far from the first time that an uninspiring company miraculously pulled a breakthrough quarter out of its hat immediately prior to going public…only to subsequently resume its previous mediocrity.
Now let’s examine LOCO’s store growth. The company hit 200 locations 23 years ago in 1991, and currently has approximately 400 locations. A 100% store increase in 23 years does not an impressive growth story make.
The company’s recent store growth has been similarly uninspiring, as it added only 5 locations in 2013 and 4 in 2012. Competitor Chik-fil-A plans to open 100 franchises this year, to give one (very unfavorable) comparison.
Part of the reason for LOCO’s lack of growth prospects is that the company’s popularity is largely limited to California. In fact, at the end of 2013, a whopping 88% of the company’s stores were located in California. LOCO bulls are betting that the company will expand into new markets, but historically the company has had virtually no success doing so. In fact, LOCO had 9 stores east of the Rockies as of 2009, but ALL of these stores had closed by 2012. So, unlike CMG, LOCO has always been a very localized story…which explains why LOCO has never been a fast growing franchise but is not at all consistent with the company’s seemingly wishful projection that it may be able to achieve 8-10% store growth annually going forward. Note that even in its last “breakthrough” quarter, LOCO only increased revenues 5.7% year over year (by comparison, CMG’s second quarter revenues grew by 28%. CMG’s profit margins were likewise far more impressive- 10.5%, vs 6.7% for LOCO)
Moreover, LOCO faces very stiff competition from, among others, KFC owner Yum! Brands, and privately held Chick-fil-A. LOCO may lack the financial wherewithal to effectively compete with such dominant, relatively deep-pocketed competitors.
Even in the unlikely event that the company’s growth projections prove to be attainable, LOCO’s valuation would be extremely lofty given that LOCO is unprofitable and currently trades for about 5.5 sales (while this price/sales ratio is similar to that which is sported by CMG, as I’ve demonstrated CMG is not a remotely appropriate comparable for LOCO. More apt comparables would be Darden Restaurants (DRI), which trades for roughly 1.4 sales, and Brinker International (EAT) which trades for roughly 1.3 times sales).
The company’s aforementioned debt load is a mountainous $288 million. While some LOCO investors no doubt imagine that the company’s IPO proceeds will be used to somehow fuel prodigious growth, the company has explicitly stated that the IPO proceeds will be used to pay down the company’s debt…which will remain daunting (around $183 million, or approximately half of the company’s capitalization) even after that happens.
In summary, LOCO’s valuation is ridiculous and unsustainable, to a degree which is reminiscent of IPO flame-outs PBPB and NDLS. I believe that the stock will similarly crater as IPO momentum and hype fade, and the catalysts outlined below kick in.
1) LOCO’s 25 day quiet period ends on September 2, and I think that if the stock is trading at anywhere near current levels there is a very good chance that analyst price targets will be well below the stock’s trading price, creating a headwind for continued price appreciation.
2) End of lockup period on January 20, 2015- admittedly, this is not a near term catalyst. I’m mentioning it, however, because if the stock is anywhere near current levels going into unlock, we should see a tremendous amount of profit-taking in LOCO due to the unlock. So, while I believe that the stock will more than likely be hit hard at some point in the next couple of months, I view the unlock as a sort of “safety net” which is very likely to allow for a profitable exit of this short in the (unlikely imho) event that LOCO is able to maintain current price levels over the remainder of 2014.