Newly public El Pollo Loco (LOCO) shares have been red hot since going public last Friday. Shares went public at $16, hit the after market at $18.80, and closed at $38.75 on Thursday, a soaring nearly 150% higher over the past week.
El Pollo Loco has carved out its own niche market in fast food. The company specializes in fire-grilled, marinated chicken with a Mexican twist. There are plenty of healthy options on the menu, and its restaurants offer salads, grilled chicken, traditional Mexican dishes like tacos and burritos, and everything in between.
Many investors are fond El Pollo Loco’s business model and growth potential. However, a triple-digit return in one week certainly raises some eyebrows. It seems that there are two causes behind the astronomical gains: IPO underpricing and a genuinely promising future.
The Deal Was Too Small
El Pollo Loco only sold 6 million shares to the public out of 35 million shares in existence. The massive price increase is simple economics: when demand exceeds supply, the share price is going to rise.
Investors are always looking for the next big thing in the food industry. With McDonalds (MCD) worth $93 billion, Yum! Brands (YUM) worth $30 billion, Chipotle (CMG) worth $21 billion, and Panera Bread (PNRA) worth $4 billion, many investors are willing to take a gamble on the next fast food sensation. El Pollo Loco at a $1.4 billion valuation certainly fits the bill, continuing to drive demand for the stock.
The action in the stock probably means that El Pollo Loco is "crying fowl" on Jeffries, Morgan Stanley, and Baird, the company’s IPO underwriters. The deal was horrendously underpriced, and El Pollo Loco missed out on tens of million of dollars that could have been used to help finance its expansion efforts.
Shares continue to rise because institutional investors have locked up shares as long-term investments and have no intentions to sell this early. This lack of supply is why El Pollo Loco rose yet another 12% on Thursday despite the market’s 300-point selloff.
El Pollo Loco’s mispriced and under allocated IPO isn’t the only factor behind the stock’s explosive rally. The company also has tremendous fundamentals and enormous expansion potential, a rare combination for a newly IPO’d company.
El Pollo Loco has 400 locations in California, Texas, Arizona, Nevada, and Utah, and the company estimates that the U.S. could have an appetite for another 2300 restaurants. Obviously, eastward expansion will take years, but stocks with high long-term growth rates always deserve to trade at higher multiples.
El Pollo Loco also had stellar 7.2% same-store sales growth in Q1, a great indicator for overall brand popularity. Francis Gaskins’ IPO report also revealed a pro-forma P/E ratio of 15.5, a more than reasonable multiple given the company’s plans to grow restaurants by 8%-10% annually.
Is the LOCO’s Fire Too Hot?
In the short run, El Pollo Loco shares are probably overheated. The IPO’s underwriters underpriced the stock and the company opted not to IPO enough shares to satisfy overall demand. Investors may be “tasting the fire” right now, but shares are sure to take a rest at some point when demand is satisfied.
However, El Pollo Loco’s current valuation doesn’t seem too unreasonable. Given the company’s same-store sales growth and the sheer size of El Pollo Loco’s potential market, it’s easy to see why the stock has doubled this week. The company’s growth period is only beginning, and it will be interesting to see if El Pollo Loco can execute its plan to successfully position itself in the already crowded fast food market.