Furthermore, it was found that average lunch checks have increased 5% year over year, which has put pressure on consumer decisions.

This decline in traffic, particularly within lunch, and the higher check prices create further concern when, after 2Q16, Zoe’s reported that 3.1 percentage points of its 4% comparable store sales was due to price increases. This price increase adds onto the 2.1% increase in price in 1Q16. If consumers are balking at price, Zoe’s faces a situation where its low margin does not allow it to match competitor price (and maintain profitability) while also growing revenue at rates the market has come to expect. If it chooses to discount price, already low margins are pressured. On the other hand, if it maintains price in an effort to maintain margins, it faces losing customers to competition that can provide a “more valuable” offering. In either situation, Zoe’s is unable to meet the lofty expectations already baked into its stock price.

Insider Action Is Low While Short Interest Is High

Over the past 12, two thousand insider shares have been purchased and 159 thousand have been sold for a net effect of 157 thousand insider shares sold. These sales represent under 1% of shares outstanding. Additionally, there are 5.7 million shares sold short, or just under 29% of shares outstanding. A large portion of investors recognizes the overly optimistic expectations embedded within ZOES.

Impact of Footnotes Adjustments and Forensic Accounting

In order to derive the true recurring cash flows, an accurate invested capital, and a real shareholder value, we made the following adjustments to ZOES’s 2015 10-K:

Income Statement: we made $17 million of adjustments with a net effect of removing $9 million in non-operating expenses (4% of revenue). We removed $13 million related to non-operating expenses and $4 million related to non-operating income. See the adjustments made to ZOES’s income statement here.

Balance Sheet: we made $191 million of adjustments to calculate invested capital with a net increase of $115 million. The most notable adjustment was $152 million (85% of net assets) related to off-balance sheet operating leases. See all adjustments to ZOES’s balance sheet here.

Valuation: we made $191 million of adjustments with a net effect of decreasing shareholder value by $188 million. Aside from the operating leases noted above, one notable adjustment was the inclusion of $2 million (<1% of market cap) due to excess cash.

Dangerous Funds That Hold ZOES

The following funds receive our Dangerous-or-worse rating and allocate significantly to Zoe’s Kitchen.

  1. Scotia Dynamic U.S. Growth Fund (DWUGX) – 5.1% allocation and Dangerous rating.
  2. DF Dent Small Cap Growth Fund (DFDSX) – 1.2% allocation and Dangerous rating.

This article originally published here on September 26, 2016.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

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