Market Overview

Analysts Mostly Agree on El Pollo Loco's Growth Potential, But Disagree On Valuation

Shares of El Pollo Loco (NASDAQ: LOCO) soared above $30 in its first day of trading, up over 100 percent from the company's initial public offering price.

Investors were eager to grab up shares of El Pollo Loco, translated as “The Crazy Chicken” given the fact that it is a fast casual chain hoping to copy the tremendous success of Chipotle Mexican Grill (NYSE: CMG).

By the beginning of March, shares of El Pollo Loco were trading north of $40, but a plethora of cautious calls from analysts on Tuesday brought shares below $30.

William Blair: Aggressive growth possible given market trends

Sharon Zackfia at William Blair initiated coverage of El Pollo Loco with an Outperform rating and no assigned price target on Tuesday.

Related: Comparing El Pollo Loco To Chipotle Gives A Value of $3 Per Share

Zackfia believes that El Pollo Loco and its concept of fire-grilled chicken and Mexican entrees could benefit from several growing trends within the restaurant industry. The trends include increasing demand for healthier meals, increasing demand for fresh, hand-made, made-to-order menu items and an overall growing popularity of chicken and Mexican-themed meals in the United States.

"Management began to re-position El Pollo Loco in 2012 with a multipronged strategy to distinguish the concept from its quick-serve competitors, starting with a broad menu revamp designed to place a renewed focus on the concept's differentiating characteristics while giving the brand a more upscale look and feel," Zackfia wrote. "The company also refocused on its core bone-in chicken, inclusive of new marketing messaging that highlighted its authentic preparation and ingredients."

And so a new fad was born.

At the same time Chipotle Mexican Grill was beginning to gain attention with its higher-priced premium products, so was El Pollo Loco. El Pollo Loco's entrees are priced at an approximate 10 percent to 15 percent premium to quick-serve offerings, according to Zackfia.

From 2009 through 2011, El Pollo Loco saw its weekly sales grow at an annual compounded rate of 0.6 percent. Following the company's transformation in 2012, sales grew at an annual compounded growth rate of 17.6 percent.

Looking forward, Zackfia notes that the company will bolster its presence in existing markets while entering new markets with two to three locations in new cities. As such, 60 percent to 70 percent of the company's growth will occur within existing markets. The company has already identified 325 potential sites, including more than 200 additional sites in California.

Zackfia is projecting system-wide unit growth of two percent to three percent in 2014, five percent to six percent in 2015 and eight percent to nine percent in 2016, including a doubling of company-owned unit growth to ten percent by 2016.

Bottom line, "the reinvigoration of El Pollo Loco's sales trends following management's efforts has been impressive," Zackfia noted as the company has successfully positioned itself between the quick-service and fast-casual sub segments.

Jefferies: ‘Plucky' valuation, shares fairly valued

Andy Barish of Jefferies initiated coverage of El Pollo Loco with a Hold rating and $30 price target on Tuesday.

Barish, like Zackfia, believes that El Pollo Loco is a restaurant chain that is well positioned to benefit from industry trends.

"We think El Pollo Loco will grow earnings per share 15 percent to 20 percent as it accelerates unit growth out of California and positions itself to capture Fast Casual guests with the value & convenience of Quick Service Restaurants," Barish wrote before warning investors that "at just 400 units today though, 88 percent of which are in California, there is execution risk."

In addition to an "execution risk," Barish notes that current valuation already includes the company's expansion to Texas and other new markets.

The analyst sees the company growing its total store count from 400 to 2,000. However, the majority of locations will be located within established markets where it has a "strong heritage." The analyst also sees existing markets accounting for 70 percent to 75 percent of store openings over the next few years.

Speaking of valuations, Barish believes that the market has become more wary of high-multiple stocks and "momentum" names which includes several restaurant stocks.

"Although we appreciate its long-term opportunity, we find it hard to assign a higher valuation to the stock given execution risk in new markets, and high expectations for consistently strong quarterly results going forward," Barish wrote.

Bottom line, Barish recommends investors sit on the sidelines and let the stock grow into its multiple.

Morgan Stanley: Overpriced due to growth concerns

John Glass of Morgan Stanley initiated coverage of El Pollo Loco with an Underweight rating and $22 price target on Tuesday.

Glass believes that El Pollo Loco is a strong regional brand, not a national brand that could easily enter new markets.

"We believe this is a strong example of a regional Quick Serve Restaurant concept with ‘on trend' positioning, talented management, and plenty of white space expansion potential," Glass wrote. "But the market appears to be paying a premium for these elements far above what we consider to be fair value – and well above any reasonable peer comparable."

Glass notes that El Pollo Loco could easily become a 2,000+ unit chain nationally, but the majority of its locations will be located within established markets like Southern California. As such, the company has not proven to investors that its concept is "portable" to new markets such as Texas.

Looking forward, Glass is estimating El Pollo Loco could deliver an earnings per share growth of 10 percent to 15 percent through 2016, and 15 percent to 20 percent growth thereafter.

However, valuation is one of the strongest determining factors in Glass' Underweight rating.

The analyst notes that shares are trading at roughly 56 times 2015 estimated earnings per share and 21 times 2015 estimated EBITDA. This would make the name the most expensive in its peer group "by a wide margin in most cases." Additionally, the company's growth rate of earnings, especially over the next two years is expected to be below the peer average.

Bottom line, "any way you stack it, El Pollo Loco looks expensive versus peers."

Shares of the company closed Tuesday at $29.91.

Latest Ratings for LOCO

DateFirmActionFromTo
Aug 2014JefferiesInitiates Coverage onHold
Aug 2014BairdInitiates Coverage onNeutral
Aug 2014Morgan StanleyInitiates Coverage onUnderweight

View More Analyst Ratings for LOCO
View the Latest Analyst Ratings

Posted-In: Andy Barish Chipotle Mexican Grill El Pollo LocoAnalyst Color News Price Target Initiation Analyst Ratings

 

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