Will These Companies Become the Next Chipotle?

It was an incredible IPO for Potbelly (NASDAQ: PBPB  ) , as fast-casual restaurants continue to captivate Wall Street. Potbelly's 130% IPO gain compliments a strong performance from Noodles & Company (NASDAQ: NDLS  ) on its IPO and strong annual gains from Chipotle Mexican Grill (NYSE: CMG  ) . While investors are buying on the strength of the fast-casual space, will Noodles or Potbelly ever replicate the performance that we've seen with Chipotle?

Let's look at the numbers
First, let's look at some boring numbers from the company's S-1 IPO prospectus , based on fiscal year 2012 fundamentals. Moreover, let's stack Potbelly up against a company of similar size in the fast-casual space to determine if there is any value in either company.

 

Potbelly

Noodles

Market Cap

$930 million*

$1.3 billion

Revenue

$274 million

$300.4 million

Full-Year Revenue Growth

15.5%

17%

Net Income

$7.1 million

$5.2 million

Total Stores

295

339

*28.5 million outstanding shares times current price of $32.75

The growth between these two companies is comparable, with both bringing in similar amounts of revenue per store. Thus, Noodles is a larger company with more open stores, and is the more expensive stock.

However, investors should be encouraged about the profits that Potbelly has produced for a company of its size. Compared to Noodles, Potbelly reported 35% more profit last year despite having less revenue. This indicates that Potbelly is operating more efficiently, which might be attractive to investors in this space.

With all things considered, the market seems to have gotten Potbelly's valuation right, especially when compared to Noodles. But if I had to choose one, Potbelly's profit sets it apart as the favorite.

The next Chipotle?
One reason there has been so much excitement surrounding fast-casual restaurants is that this sector's growth outperforms the overall restaurant sector. Also, everyone is looking for the next Chipotle.

Given the success of Noodles' IPO, and now Potbelly, there is little doubt that more fast-casual companies will elect to go public. Yet, this fact does not mean that any will become the next Chipotle.

For investors, one thing's for sure: These companies are yet to replicate the growth of Chipotle. We're talking about companies that have top-line growth below 20% and closer to 15% on an annualized basis, and are yet to exceed $500 million in revenue.

Essentially, Noodles, Potbelly, and similar companies are still small. These companies should have room to expand, market, and drive 30% growth to their top lines. In theory, as a company grows larger its targeted market grows smaller, and top-line growth becomes more difficult to achieve.

For example, from 2009 to 2010 Chipotle increased revenue from $1.52 billion to $1.83 billion . In other words, Chipotle saw growth greater than 20% year over year, and it was five times larger than either Noodles or Potbelly.

So, why is this comparison of growth per size of a company relevant to you as an investor? The answer lies in company worth, and the premium that is being placed on these companies.

Chipotle trades at 4.5 times sales and 45 times earnings. Potbelly and Noodles trade at 3.4 and 4.3 times sales respectively, and price/earnings multiples that are in the multi-hundreds. Thus, both are valued similarly to Chipotle, but neither is worthy of this multiple due to lack of growth.

Final thoughts
Like I said, Noodles and Potbelly are comparable in relation to each other, but to larger Chipotle – the company that both are trying to become – neither is even close. Chipotle's current revenue growth of 18% still exceeds both Noodles and Potbelly. The difference is that Chipotle has nearly $3 billion in annual revenue. The bottom line is that neither Noodles nor Potbelly have proven to be national trends, but rather nice companies that may never become the next Chipotle.

As for investors, enjoy your gains now. Don't expect that a Chipotle-like valuation of $13 billion plus will occur in your lifetime. Instead, be realistic, and use growth as a guide for consumer interest.


 

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