Should You Be Underweight on Potbelly Corporation?

The lackluster results of Potbelly Corporation  (NASDAQ: PBPB  )  make it just another restaurant casualty with the winter blues. Its 2014 outlook isn't bad and it may remind you a bit of that of Yum! Brands (NYSE: YUM  ) . However, in addition to its sky-high valuation, the sandwich company's conference call revealed a unique concern that is worrisome for the long term.


Source:  Potbelly.

The results
Potbelly Corporation reported its fiscal fourth-quarter results on Feb. 18. Calendar-adjusted revenue increased 9.9% to $74.8 million. Same-store sales inched up 0.7%. Tax-adjusted net income gained 35% to $1.9 million or $0.06 per share. Only the net income growth impressed here, but even then the company's small net income makes larger percentage gains not much of a challenge to accomplish.

CEO Aylwin Lewis blamed external factors. He stated, "There is no question the external environment was disruptive during the quarter." On the conference call, Lewis added, "Fourth quarter was a very challenging external environment highlighted by the October government shutdown in Washington, D.C., and the disruptive winter weather conditions that affected [the] majority of our markets in December."

The winter storms have been a common complaint among many restaurant chains, but the government shutdown is a new one. It raises the question: If Potbelly got a gut punch just from that, how sensitive is this chain to the economy? Is it more of a cyclical business than other chains such as Chipotle Mexican Grill (NYSE: CMG  ) and Yum! Brands' Taco Bell, Pizza Hut, and Taco Bell?

Grilling growth
Chipotle Mexican Grill has a 2014 P/E of more than 50 according to analysts, who call for 20% growth next year to match the company's stated goal of 20%. Chipotle has a P/E roughly 10 points higher than that of Potbelly, which also expects 20% earnings growth.

Considering that Chipotle Mexican Grill has similar or better growth stats than Potbelly -- with growth of 21% in revenue, 9% in same-store sales, and 30% in earnings per share -- it would seem that Chipotle should be the one with the much higher P/E ratio, yet it is the other way around. This suggests that Potbelly may be a bit overvalued.

Meanwhile, Yum! Brands, like Potbelly and Chipotle, targets 20% earnings-per-share growth this year as well. It has a long history of double-digit earnings growth. Last year was the first year out of the last 12 that it didn't hit this goal, and even that only resulted from a poultry scare in China that temporarily beat up its business in the country badly and brought down the results of the entire company. Yum! Brands trades with a 2014 analyst-estimated P/E of around 20, so it would appear much cheaper than Potbelly for the same expected earnings growth.

Source: Potbelly.

The flip side of the roll
In Potbelly's defense, the company doesn't hide behind its lack of same-store sales growth. "In reality our model does not require heroic comp growth in order to achieve healthy return and to grow our profits."

Potbelly aims for "neighborhood" growth and to be "the" place people go to lunch. It plans to expand locations more within "hubs" rather than just driving business at each specific location. This sounds like a sort of intentional cannibalization to decrease lines and increase convenience. It might just work over the long term.

Foolish final thoughts
If we take Potbelly at its word, same-store sales are not the metric to follow, even though that's often the way to go with other restaurant chains. Unit growth is the metric to follow here. Also, of course, earnings per share. As of now, both of those don't seem to be growing aggressively enough to justify Potbelly's P/E ratio. Fools should wait on the sidelines until either the stock price gets more in line with a P/E that matches its growth, perhaps in the 20s, or until Potbelly shows signs that it will pick up the pace on the growth trend.

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