Fool contributor Rick Munarriz recently wrote an interesting article featuring five restaurants growing faster than both Chipotle Mexican Grill (CMG -1.34%) and the newly public Potbelly (PBPB 1.46%).
Out of the five restaurants, I noticed Ignite Restaurant Group (NASDAQ: IRG), which posted the highest quarterly year-over-year sales growth among the five companies, at 71.6% (for the comparable 13-week period). Potbelly and Chipotle experienced quarterly year-over-year revenue growth of 11.7% and 18.2%, respectively. Should we get excited about Ignite Restaurant because of its high growth?
High sales growth but little profitability
Ignite's high sales growth came from two sources: the recent Macaroni Grill acquisition, which contributed $86 million to revenue, and a 1.3% rise in Joe's and Brick House's same-restaurant sales. While Joe's delivered $129.6 million in sales in the recent quarter, the sales of Brick House reached $12.5 million.
The significant growth in revenue, however, did not come with profitability. Macaroni Grill is the greatest contributor in revenue, but a significant drag in Ignite Restaurant's profitability and business performance. Macaroni Grill experienced as much as 7.4% drop in same-restaurant sales in the period of April through July. Thus, turning Macaroni Grill around seems to be the key for Ignite Restaurant in the near future.
What Ignite Restaurant has been doing to solve this issue is focusing on new campaigns like its "Summer Uncorked" campaign in June, telling people about the unique story of a Macaroni Grill experience. Within three months, this has been successful in reducing monthly comparable-restaurant sales from negative 11.5% in April to negative 1.6% in July. However, in order to achieve that result, Ignite Restaurant had to spend $2 million more than it originally planned in marketing activities. . So in addition to curtailing marketing spending, it will need to manage its labor costs and food costs more efficiently to drive profitability.
Chipotle is the most profitable business
With the current earnings before interest, taxes, depreciation, and amortization of around $29 million, Ignite Restaurant is not priced cheaply on an absolute basis, at more than 18.5 times EV/EBITDA (enterprise value/EBITDA). However, relatively speaking, it has a lower valuation than Chipotle and Potbelly. While Chipotle is priced at more than 22.7 times EV/EBITDA, Potbelly is the most expensive, at 27.5 times EV/EBITDA.
Investors might feel more comfortable owning Chipotle than Potbelly or Ignite Restaurant because of its profitability. In the past 12 months, Chipotle posted an operating margin of 16.7%, much higher than Potbelly and Ignite Restaurant's operating margins of 3.6% and 3.2%, respectively.
In the long run, I think Chipotle will continue to grow its business via both innovating new food items and committing to raising the safety standard of its food ingredients. It is expanding the presence of Sofritas vegan tofu entrée after a successful roll-out in California. According to Chipotle, most of its ingredients are already GMO (Genetically Modified Organism)-free, and it is also voluntarily labeling GMOs in its food.
Potbelly is the most expensive company among the three. The company focuses on sandwiches, with a passion to be "the best place for lunch." The concept sounds quite appealing, and indeed the business has grown quite nicely. The number of shops has grown from only two in 1997 to as many as 300 in 2013. . In the long run, management expects to increase the shop count by at least 10% annually.
With a high valuation and little profitability, however, I personally do not want to be involved in Potbelly at the current price. On the other hand, investors might find it interesting that Starbucks' chairman and CEO Howard Schultz indirectly invested in Potbelly via his venture-capital shop, Maveron. Moreover, Peter Bassi, the former chairman of Yum! Brands, is currently the independent director of Potbelly.
My Foolish take
Ignite Restaurant might excite investors with significant growth in the top line, supported by the Macaroni Grill acquisition. However, the growth in the top line has not gone to the bottom line yet. Joe's and Brick House are still growing, but Macaroni Grill is still a drag on business performance. If Ignite Restaurant could turn around Macaroni Grill by managing costs efficiently, as well as spending on advertising wisely to maximize traffic, it could provide great upside for investors in the next several years .
