Should You Wait for the Euphoria to Subside at Potbelly?

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

According to the National Restaurant Association, the restaurant industry is on pace for $661 billion in sales in 2013, up 3.8% from the prior year.  With Americans continuing to hit the dining-out scene en masse, investors are on the lookout for the next Chipotle Mexican Grill (NYSE: CMG  ) or Panera Bread (NASDAQ: PNRA  ) . 

Some investors have christened newly public Potbelly (NASDAQ: PBPB  ) as the heir apparent, driving its stock up sharply from the initial public offering price. So, should investors dive in or wait for a post-IPO cool down?

What's the value?
Potbelly is a quirky chain of sandwich shops, 280 at last count, that have an antique look and feel -- no doubt due to its inception as a Chicago antique shop. The company creates efficiency in its food purchases by offering a limited menu, mainly consisting of an assortment of oven-baked sandwiches, complemented by hand-dipped shakes and homemade cookies. With health consciousness on its customers' minds, Potbelly has also tweaked its menu in recent years, introducing smaller Skinnies sandwich sizes in 2008 and salads in 2010.

In FY 2013, Potbelly has continued its solid growth pattern, with revenue up 11.7%, aided by positive comparable-store sales and a double-digit increase in its store count. The company's adjusted profitability, however, dipped slightly due to rising occupancy costs from its push into urban markets, notably New York and Boston. 

Nevertheless, Potbelly's geographic expansion will reduce its exposure to its home-Illinois market, accounting for roughly 30% of its store base, and should ultimately help it to generate better profitability through scale efficiencies.

Looking for an edge
While Potbelly has substantial growth opportunities, with operations in only 18 states and Washington, D.C., investors may have gotten ahead of themselves, pushing the company's market valuation to almost 25 times 2012 adjusted earnings before interest, taxes, depreciation, and amortization. As such, investors might want to look to its aforementioned competitors for a more favorable investment risk-reward ratio. 

Both Chipotle and Panera have better overhead efficiency, due to their much larger operating bases, and they each generate excess cash flow that they are returning to shareholders, primarily through stock repurchases.

The larger of the two, Chipotle, was the likely operating blueprint for Potbelly, with a similarly simple menu, which in its case consists mainly of burritos, tacos, and salads. The company, however, also leverages its mission of "Food With Integrity" and responsible business practices to create word-of-mouth advertising that lowers its required marketing expenditures. In addition, Chipotle's efficient store format and multi-tasking employees allow it to generate a high store margin, roughly 27% in its latest fiscal year.

In FY 2013, Chipotle's business has been humming along, with a 16.7% top-line gain that was driven by higher comparable-store sales and the addition of nearly 190 new stores. Its operating profitability did decline slightly, mainly due to higher commodity costs, but the company was able to partially offset the negative impact with greater efficiency in its administrative support operations. 

More importantly, Chipotle's strong operating cash flow, $389 million for the period, is allowing the company to continue its growth trajectory, with plans for at least another 180 new stores in FY 2014.

Meanwhile, Panera has also been growing, albeit at a slower rate than Chipotle, adding roughly 80 locations to its base of more than 1,700 total stores in FY 2013. While the company's overall profitability has held up well year-to-date, its store operating margin has declined as a result of a deceleration in its comparable-store sales, which came in at just 1.7% in the most recent quarter. 

On the upside, management has acknowledged its operational execution issues and is working on remedies to increase customer visits to its stores, including adding store personnel to speed up the ordering process and making better use of its advertising dollars.

The bottom line
Potbelly has delivered pretty consistent top-line growth over the past few years, but investors have raised the expectation bar dramatically via a substantial increase in the company's valuation since its initial public offering. With plans to increase its store base by 10% per year going forward, Potbelly will need to keep improving its store productivity and efficiency, if it hopes to meet those lofty expectations. 

While the company isn't a flash in the pan, prudent investors might want to see some margin improvement and geographic maturation in its business before going long. 

One stock to buy now
While Potbelly stormed out to a huge gain, investors might be better off waiting on the sidelines for the stock to cool. But if you're looking for growth, the Motley Fool's chief investment officer has hand-picked one such opportunity in our new report: "The Motley Fool's Top Stock for 2013." To find out which stock it is and read our in-depth report, simply click here. It's free!

Read/Post Comments (2) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 26, 2013, at 1:37 PM, zack777 wrote:

    Chipotle, Panera & Potbelly all have their niches. But you must realize that Potbelly prices are significantly cheaper than the similar items at Chipotle and Panera. That cost saving compared to those 2 competitors will help drive Potbelly's growth in my opinion.

  • Report this Comment On October 29, 2013, at 10:29 AM, kevbo34 wrote:

    It tickles me that the title of this article refers to the Euphoria of the Potbelly's IPO when most of us who own the stock bought it in the aftermarket of which has been anything bought euphoric..

Add your comment.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2696244, ~/Articles/ArticleHandler.aspx, 9/28/2016 9:40:41 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,339.24 110.94 0.61%
S&P 500 2,171.37 11.44 0.53%
NASD 5,318.55 12.84 0.24%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/28/2016 4:03 PM
CMG $418.31 Down -0.64 -0.15%
Chipotle Mexican G… CAPS Rating: ****
PBPB $12.59 Down -0.42 -3.23%
Potbelly CAPS Rating: **
PNRA $192.18 Down -1.33 -0.69%
Panera Bread CAPS Rating: ****