Fast food chain El Pollo Loco (NASDAQ:LOCO) missed analysts' expectations in Q3 FY2023, with revenue flat year on year at $120.4 million. Turning to EPS, El Pollo Loco made a non-GAAP profit of $0.19 per share, improving from its profit of $0.14 per share in the same quarter last year.
El Pollo Loco (LOCO) Q3 FY2023 Highlights:
- Revenue: $120.4 million vs analyst estimates of $120.9 million (small miss)
- EPS (non-GAAP): $0.19 vs analyst estimates of $0.19 (2.7% beat)
- Gross Margin (GAAP): 27%, up from 17.1% in the same quarter last year
- Same-Store Sales were up 0.8% year on year
- Store Locations: 492 at quarter end, increasing by 7 over the last 12 months
With a name that translates into ‘The Crazy Chicken’, El Pollo Loco (NASDAQ:LOCO) is a fast food chain known for its citrus-marinated, fire-grilled chicken recipe that hails from the coastal town of Sinaloa, Mexico.
The company was founded in 1980 in Los Angeles, California. While it started with that signature chicken dish, the chain has expanded its offering to include a variety of Mexican-inspired dishes like tacos, burritos, and quesadillas. In response to changing consumer tastes, El Pollo Loco now offers a ‘fit’ menu featuring items such as Keto burritos and salads.
The core El Pollo Loco customer is diverse but principally a middle-income individual or family seeking a tasty and unique menu that is also affordable. More specifically, the core customer is likely someone who appreciates the depths of Mexican food beyond just the simple taco.
El Pollo Loco locations are moderate in size, catering to the fast food and casual segments. There's often seating available, but it's typically limited compared to large sit-down restaurants. There are booths, tables, and sometimes outdoor patios. The vibe inside mirrors its Californian roots with a modern, relaxed atmosphere featuring hues of orange and earth tones. Artwork or motifs hinting at its Mexican culinary heritage complete the look. In all, it is a laid back, casual atmosphere where no one minds if things get lively or even celebratory.
Traditional Fast Food
Traditional fast-food restaurants are renowned for their speed and convenience, boasting menus filled with familiar and budget-friendly items. Their reputations for on-the-go consumption make them favored destinations for individuals and families needing a quick meal. This class of restaurants, however, is fighting the perception that their meals are unhealthy and made with inferior ingredients, a battle that's especially relevant today given the consumers increasing focus on health and wellness.Competitors offering Mexican-inspired fare or specialty chicken dishes include Chipotle (NYSE:CMG), Fiesta Restaurant Group (NASDAQ:FRGI), Chuy’s (NASDAQ:CHUY), and private company Qdoba.
El Pollo Loco is a small restaurant chain, which sometimes brings disadvantages compared to larger competitors benefitting from better brand awareness and economies of scale.
As you can see below, the company's annualized revenue growth rate of 1.73% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was weak, but to its credit, it opened new restaurants and grew sales at existing, established dining locations.
This quarter, El Pollo Loco's revenue grew 0.43% year on year to $120.4 million, falling short of Wall Street's estimates.
Number of Stores
A restaurant chain's total number of dining locations is a crucial factor influencing how much it can sell and how quickly company-level sales can grow.
When a chain like El Pollo Loco is opening new restaurants, it usually means it's investing for growth because there's healthy demand for its meals and there are markets where the concept has few or no locations. El Pollo Loco's restaurant count increased by 7, or 1.44%, over the last 12 months to 492 locations in the most recently reported quarter.
Taking a step back, El Pollo Loco has generally opened new restaurants over the last eight quarters, averaging 1.36% annual increases in new locations. This growth is decent compared to other restaurant businesses but should be taken lightly as the industry is quite mature. Analyzing a restaurant's location growth is important because expansion means El Pollo Loco has more opportunities to feed customers and generate sales.
El Pollo Loco's demand within its existing restaurants has generally risen over the last two years but lagged behind the broader sector. On average, the company's same-store sales have grown by 4.98% year on year. With positive same-store sales growth amid an increasing number of restaurants, El Pollo Loco is reaching more diners and growing sales.
In the latest quarter, El Pollo Loco's year on year same-store sales growth was flat, or 0.8%. By the company's standards, this growth was a meaningful deceleration from the 3.8% year-on-year increase it posted 12 months ago. One quarter fluctuations aren't material for the long-term prospects of a business, but we'll watch El Pollo Loco closely to see if it can reaccelerate growth.
Gross Margin & Pricing Power
We prefer higher gross margins because they make it easier to generate more operating profits.
El Pollo Loco has poor unit economics for a restaurant company, leaving it with little room for error if things go awry. As you can see below, it's averaged a 19.8% gross margin over the last two years. This means the company makes $0.20 for every $1 in revenue before accounting for its operating expenses.
In Q3, El Pollo Loco's gross profit margin was 27%, marking a 9.9 percentage point increase from 17.1% in the same quarter last year. One quarter's performance shouldn't determine your long-term view of a company, but El Pollo Loco's margin expansion is a wonderful sign in the near term. It shows the company received better terms from its suppliers, and if this trend continues, it could suggest a less competitive environment where it has better pricing power and more stable input costs (such as ingredients and transportation expenses).
Operating margin is a key profitability metric for restaurants because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
This quarter, El Pollo Loco generated an operating profit margin of 11.4%, up 5.6 percentage points year on year. This increase was encouraging and driven by stronger pricing power or lower ingredient/transportation costs, as indicated by the company's larger rise in gross margin.Zooming out, El Pollo Loco was profitable over the last two years but held back by its large expense base. It's demonstrated mediocre profitability for a restaurant business, producing an average operating margin of 7.72%. However, El Pollo Loco's margin has improved, on average, by 2 percentage points each year, an encouraging sign for shareholders. The tide could be turning for El Pollo Loco.
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q3, El Pollo Loco reported EPS at $0.19, up from $0.14 in the same quarter a year ago. This print beat Wall Street's estimates by 2.7%.
Between FY2020 and FY2023, El Pollo Loco's adjusted diluted EPS dropped 2.05%, translating into 0.68% average annual declines. We tend to steer our readers away from companies with multiple years of falling EPS, especially restaurants, which are arguably some of the hardest businesses to manage because of constantly changing consumer tastes, input costs, and labor dynamics. If there's no earnings growth, it's difficult to build confidence in a company's underlying fundamentals, leaving a low margin of safety around its valuation (making the stock susceptible to large downward swings).
On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 14.1% year-on-year increase in EPS each quarter.
Return on Invested Capital (ROIC)
El Pollo Loco has a decent track record of investing in profitable projects and has the flexibility to engage with financiers if it wants to raise or borrow capital. Its five-year average return on invested capital (ROIC) is 10.2%, slightly better than the broader restaurant sector.
We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from El Pollo Loco's Q3 Results
With a market capitalization of $281.8 million and more than $13.8 million in cash on hand, El Pollo Loco can continue prioritizing growth.
We struggled to find many strong positives in these results. Its gross margin and revenue missed Wall Street's estimates, driven by lower-than-expected same-store sales. Overall, the results could have been better. The stock is flat after reporting and currently trades at $8.7 per share.
Is Now The Time?
El Pollo Loco may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We cheer for everyone who's improving the lives of others, but in the case of El Pollo Loco, we'll be cheering from the sidelines. And while its stable growth in new restaurants shows it has steady demand, unfortunately, its gross margins make it more challenging to reach positive operating profits compared to other restaurant businesses.
El Pollo Loco's price-to-earnings ratio based on the next 12 months is NaNx. While we've no doubt one can find things to like about El Pollo Loco, we think there might be better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.
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