Are Investors Better Served by Smaller Restaurant Chains or Industry Giants?

Recent data from the National Restaurant Association, which publishes a monthly Restaurant Performance Index (RPI), points to continued improvement in the outlook for restaurants' operating performance. The RPI reached a five-month high in November as restaurants reported that same-store sales and customer traffic were up.


Today we are looking at two smaller, up-and-coming restaurant companies: relatively recent IPOs Potbelly (NASDAQ: PBPB  ) and Chuy's Holdings (NASDAQ: CHUY  ) . We'll also look at a quick-service restaurant chain that is, well, a whopper in its industry: Burger King Worldwide (NYSE: BKW  ) .

Who doesn't like a good sandwich?
Potbelly, which just competed its IPO on Oct. 9, 2013, describes its restaurants as "neighborhood sandwich shops offering simple, tasty food." The company adapts its restaurants to each location through locally themed vintage decor.

The company has a stated mission "to make people really happy and improve each day." Through the third quarter of 2013, Potbelly owned and operated 288 of these sandwich shops in 18 states. In addition, it has seven domestic franchised locations and twelve in the Middle East.

In its December investor presentation, one slide showed a map of the United States which gave the number of Potbelly sandwich shops in each state. Most of the south and west, including California, remained what the company termed "whitespace," open territory for developing new locations in the future.  

The company has significantly ramped up its store development efforts, even before receiving the proceeds from its IPO. After only opening six new shops in 2009, for example, Potbelly said that 40-42 new stores would open in fiscal year 2013.

The company's third-quarter results were as satisfying as its sandwiches and salads. Total revenue jumped 11.7% over the prior year's third quarter to $78 million. At company-operated stores, comparable sales rose a healthy 2.5% for the quarter.

Overall, total expenses as a percentage of sales remained unchanged in comparison with the prior-year quarter, so the revenue increase resulted in a nice 12.7% increase in income from operations.

Authentic flavor-rich cuisine served in a fun atmosphere
Chuy's is not a large restaurant group, with 47 restaurants in 14 states, but it has an intriguing menu of Tex-Mex inspired dishes. Chuy's restaurants have a fun, irreverent atmosphere, and this company, too, tries to make each location unique to some extent, or as the company expresses it, an "unchained" look.

The company is also on the fast track to unit growth. It added nine new stores in fiscal year 2013 for a 23% increase in stores for the year. The company plans to increase this to 10 to 11 new stores in 2014.

In the third quarter, Chuy's revenue soared to $53.5 million, a 19% gain from the same quarter last year. The increase was driven by the 11 new stores that Chuy's opened during the 12-month period and a 3.1% increase in comparable-store sales. Both the average check and the average number of customers increased.

The company's overall costs as a percentage of sales held steady at 92.4%. The result was an 18.5% increase in income from operations, to just over $4 million.

The joys and challenges of being huge
Burger King truly is huge, with 13,000 locations in 91 countries. The company has embarked on a strategy of becoming a nearly completely franchise-driven entity. By doing so, Burger King has greatly reduced its operating costs.

In the third quarter, systemwide comparable sales grew by just 0.9% over the same quarter last year. In 2012's third quarter, comparable sales had risen 1.4%. Results were very good in Burger King's three international regions, highlighted by a 3.7% comparable sales increase in its Asia Pacific region. The laggard was the U.S. and Canada region, where sales were down 0.3%.

As a result of the shift to the franchise operating model, total revenue of $275 million declined nearly 40% from the same quarter of 2012. The real story was the 8% increase in adjusted EBITDA due to Burger King's lower cost structure. The adjusted EBITDA margin grew by a, so to speak, whopping 28 percentage points to 64%. Adjusted net income grew by a similarly outstanding amount, nearly 33%.

Smaller chains like Potbelly see a lot of opportunity or "whitespace" when they view the map of the United States. Burger King, with 7,404 restaurants in the U.S. and Canada, doesn't have the same opportunity to expand. In fact, in the last twelve months the company reduced its number of stores in the U.S. and Canada by 49 units.

Internationally, though, the company is finding great opportunity for growth. In the last 12 months, Burger King has added 641 new restaurants in its Europe, Middle East and Africa region, its Latin America and the Caribbean region, and its Asia Pacific region.

What we learned
Potbelly shops have wide appeal because they serve dishes that are familiar to consumers such as chicken salad and roast beef sandwiches. The Potbelly menu can please a large customer base.

In 2012 Potbelly's shop-level profit margin of 20.7% was more than 5 percentage points higher than it was in 2008. Going forward, Potbelly has set ambitious but attainable goals of 20%+ annual increases in net income growth and 10%+ annual growth in new restaurant units.

Chuy's has put its own stamp on Tex-Mex cuisine, allowing customers to enjoy dishes such as homemade blue corn tortillas or the cleverly named Chuychanga. The fact that all the dishes are made from scratch is a key selling point.  

To stay fresh and relevant with consumers, Burger King has rolled out innovative menu items like its Angry Whopper sandwich, which commands a premium price, and a healthier French fry item called Satisfries.

Burger King is doing an outstanding job of developing its brand presence internationally. At the end of the third quarter, more than 44% of its stores were outside North America. Demand for the brand is strong among franchisees in each of the three international regions, so if the economy weakens in one region, there is still opportunity in the other two.

The question is which of these chains can continue to grow its store count at a brisk pace, increase same-store sales, and improve operational efficiency to deliver more dollars to the bottom line. To me, Potbelly has the best chance to consistently achieve all three objectives.

And there is a brilliant strategic simplicity to Potbelly's store concept and menu.   

 

Looking for a great growth investment?
They said it couldn’t be done. But David Gardner has proved them wrong time, and time, and time again with stock returns like 926%, 2,239%, and 4,371%. In fact, just recently one of his favorite stocks became a 100-bagger. And he’s ready to do it again. You can uncover his scientific approach to crushing the market and his carefully chosen 6 picks for ultimate growth instantly, because he’s making this premium report free for you today. Click here now for access.


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

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 January 24, 2014, at 4:09 PM, sandiegoman wrote:

    Well, if you bit into PB on first day of trading, you're now down 30% off your investment

Add your comment.

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: 2792187, ~/Articles/ArticleHandler.aspx, 10/20/2014 6:29:47 AM

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...


Advertisement