What’s The Wealth Advisory’s “Next Chipotle”

We’ve had a number of questions about this pitch for “The Next Chipotle” from Briton Ryle, so we’re re-posting this solution from December — the stock they’re teasing, ZOES, is still the same, though it reported a great first quarter in early June and the shares popped up on the news (and came back down a bit more recently when the CFO resigned). It’s up about 30% since the promo was first distributed (or we first saw it, at least) late last year.

What follows has not been edited or revised since it first ran on December 23, 2014. Enjoy!

A quickie here for you as we batten down the hatches for the holiday break and, as the Little Gumshoes would put it, wish you a Happy Christmas Eve Eve. Perhaps this reveal of a “top secret” idea will fill your belly with good tidings…

The pitch comes in from Wealth Daily, in a free article that hints at Briton Ryle’s current recommendation from the pages of The Wealth Advisory. That newsletter might sound familiar, if only because one of our most-requested teaser solutions of late has been their pitch for what they call “Internet Royalties” that let you “get paid to watch Netflix” … that was a ridiculous tease, but underneath it we found a perfectly reasonable stock (and one that many of us already owned).

So what are they touting this time around? Ryle starts off with the story of Chipotle…

“Chipotle has tripled the number of its stores to 1,600 stores. It did $4 billion in sales over the last year.

“Chipotle shares are up 1,371%, making it one of the very best investments you could have made over the last eight years. Now, if we can just find another restaurant concept that can do as well as Chipotle…

“Chipotle’s formula is pretty basic: The company serves easily accessible food using quality ingredients at a reasonable price. It has hit on an ideal formula.

“So I was pretty excited when I found another small, up-and-coming restaurant chain with a similar formula and similar potential…”

Yes, Chipotle is another of my “sold it way too soon” stocks. I’m trying not to be bitter. But what’s his new “up and coming” chain that he’s recommending?

Here are a few hints dropped by Ryle:

“Stifel analyst Paul Westra says this ‘next Chipotle’ restaurant is ‘one of the best­-in­-history up­-and­-coming restaurant concepts… [its] early-stage momentum and store­-level profitability is even outpacing Chipotle’s… early­-stage results…’

“This company plans to have ~1,500 locations open by 2022 — roughly the same number of stores as Chipotle. If it can simply maintain the average of $1.5 million in annual sales per location, that would mean $2.4 billion in annual sales.

“So far, this company has done $160 million in trailing 12­-month revenue. For the full-year 2014, it should do $170 million, and analysts expect $218 million for 2015.

“This company currently trades with a price-to-sales (P/S) ratio of 3.5 (that’s $160 million in sales and a $560 million market cap).”

And he throws out the enticement of the potential growth — saying that it it trades at an average price/sales ratio for the sector and gets to their 1,500 restaurants goal, the stock could have a $6.75 billion market cap in seven years (which would be 1,110% growth).

So that sound pretty good, right? What’s the stock?

We fed all that into the hungry, hungry Thinkolator, and our answer came out quicker than you can bring me some figgy pudding: This is one of the relatively quiet IPOs of 2014, Zöe’s Kitchen (ZOES).

Zöe’s Kitchen is a fairly well-established small chain, they’ve been around for 20 years but just went public this year to raise money to expand and pay off their longtime private equity backers… and they did a secondary offering just last month as well (not to raise money, but to let those backers sell more shares), which has helped to keep a lid on the stock.

They have a concept that many Americans would probably call “Greek Nouveau”, but they sell the mediterranean lifestyle and the food supply chain in a similar way to Chipotle — all about fresh ingredients, fairly simple and limited menu, fresh and organic sourcing, no microwaves, etc. They have about 130 restaurants, essentially all of them company owned (they still have a few franchised locations outstanding, and a couple franchise agreements/regions from their previous attempt at growth through franchising, but they’ve been buying back those franchisees and attempting to close down the franchised locations).

And they’re adding restaurants at a feverish pace, 30 new restaurants this year, almost as many last year, and the anticipation that this growth will continue or accelerate, which is what fuels their revenue growth — they have been posting decent “comparable store sales” growth of 5-6% in recent quarters, but the real revenue growth comes from adding brand new locations into the mix… that’s how they’re getting revenue growth in the 50% neighborhood, which generally makes investors sit up and take notice.

They are not profitable, though the stores do look scaleable in part because their operating cash flow is positive (which is kind of a shorthand way of saying that the restaurants themselves look like they are not losing money — revenues cover their rent and their food and labor costs, losses are mostly due to depreciation and corporate overhead and expansion costs). That means that if this is really a popular concept that does catch on and create a legion of fans (like Chipotle did) and can grow without diluting the appeal or otherwise stumbling (unlike Potbelly Deli or Cosi, for example), then there’s clearly some potential.

The stock market is littered with the remains of failed restaurant concepts, so there’s absolutely no guarantee — Zöe’s is very much marketing itself to the Chipotle/Whole Foods shopper, and their story is based on fresh cooking and labeling and health and transparency, which I can see would appeal to a large segment of the population. Maybe not as much to the college students who line up at Chipotle for gigantic burritos, but certainly there’s a market.

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But I also really liked Cosi (as a diner, not an investor) when it was expanding like crazy in Washington, DC when I lived there a decade ago, and they had a differentiated flatbread product with fresh ingredients, and lines out the door, and that stock boomed to $40 after their IPO but is now at $1.60. There are a lot of things that can trip up a restaurant stock that’s trying to expand and create a national brand.

The financials are largely uninspiring, other than the growth rate, which is what you would expect from a rapid grower that recently went public — but they are not buying locations, they’re renting and presumably getting some buildout assistance from their landlords, so the expansion cost does not necessarily have to be overwhelming. They will be burning cash because of store openings, but with their IPO cash on hand and with the positive operating cash flow from their existing stores, they do have the capacity to do that for at least a little while.

Really, if you like the concept and think it will grow well, then they’re in better shape than a lot of small chains — the restaurants themselves look like they are, on average, very financially reasonable businesses (not Chipotle-fantastic, but reasonable, better than Potbelly or Noodles & Co or some other relatively new chains), and the fact that this base is performing well and has been for quite a while — with growing sales and positive cash flow — gives some hope for rosy thinking about what happens when that store base gets far larger.

So growth is really the whole story with ZOES. We know from Chipotle and Panera and other examples that popular and expanding fast-casual restaurant chains can be extraordinarily successful for investors… though we also know the examples of failed rollouts and failed expansions. It seems silly to predict Zöe’s fate with any great confidence, but there is room to hope. I think they’re expanding the right way — company owned stores for true brand and quality control, expansion focused on existing markets with conservative rollouts into new markets, and careful site selection… but that doesn’t mean it’s guaranteed to work.

I’ve never eaten at a Zöe’s, and that’s part of the appeal — though it was a pretty “hot” IPO back in April, and was pretty successful on the market for a few months, more insider selling (mostly from those early private equity investors) helped to really bring the stock down in recent months, and it is not a concept that most investors know or have visited, so traders don’t walk out of the subway and get c