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Are Potbelly's Bears Lazy or Right?

Late last year sandwich and salad maker Potbelly (NASDAQ: PBPB  ) brought its mission of providing "good vibes and great sandwiches," to the public markets with an initial public offering. The stock exploded, doubling almost overnight. The stock was hyped to investors as the "next" Chipotle (NYSE: CMG  ) , which didn't make any sense, and that hype left a sour taste in investors mouths as the stock slid back to $17. The post IPO hype has now officially waned and, as such, the bears have come out of hibernation. This of course leads Foolish investors to wonder what they are to think of Potbelly now? There are reasons to still be bearish on Potbelly, but the biggest bear argument is just plain lazy. 

Image courtesy of Potbelly Corporation

The laziest bear argument: Potbelly isn't "different"
The easiest (and laziest) argument for a Potbelly bear case is that it's "just a sandwich shop." Time and time again, smart investors will tell you to skip this investment because there are just so many places to get salads and sandwiches. 

While this is true, you can buy salads and sandwiches elsewhere, the argument fails to mention how common this plight is. There's really only one restaurant offering something truly "different" right now, and that's Chipotle. Just because the stock was mis-hyped as a "new" Chipotle, investors seem to fall to a lazy comparison of the two restaurants. Therefore, anything Chipotle has (that Potbelly does not), is a bad thing for Potbelly. 

Taking it a step further, many restaurants actually offer the same thing as Chipotle; just not as well. Take Qdoba, which is basically a Chipotle knock-off, that restaurant had negative (-2%) comparable sales last quarter.  Further, Sandwich chains from Jimmy John's to Jersey Mike's to Subway are growing leaps and bounds because there is a large market for quick serve sandwich chains. Is Potbelly's live music, and unique "community," atmosphere, not different? Do investors really expect live acoustic guitars at every sub shop they frequent?

Image courtesy of Potbelly Corporation

You can get sandwiches anywhere; you can also get burritos anywhere. This bear argument is lazy for two reasons: 1). it compares Chipotle and Potbelly, two restaurants that couldn't be more different and 2). it fails to notice the difference between Potbelly's stores versus a traditional sub shop. 

Examining this argument further
When you think back on the past decade or two, which restaurants have seen the biggest gains? Have they been the most "original" or unique ones? No, it's been McDonald's and Subway, two restaurants that offer food that everyone else does. Over the past few decades Subway has grown to become the largest restaurant chain in the world, at over 40,000 locations, by just offering sandwiches.

Does this mean Potbelly will have similar success? Of course not, to say so would be a "lazy bull" argument. But it does feel like many bears are looking at Potbelly's recent underperformance, and grasping to find a reason for it.

I recently read an article, from a Foolish colleague I greatly respect, that even said that Potbelly was under-performing Noodles & Company because Noodles menu was so expansive.

This argument, of course, runs in direct opposition to traditional restaurant wisdom, which says menu's should be small (to reduce costs), focused, and consistent (for brand identity). I honestly feel the fact that customers know what to expect from Potbelly (good salads, sandwiches, and shakes), is a rare positive for the company, and they've done a nice job crafting a focused message to be "the best place for lunch."

These arguments take the focus off of the real bear case for Potbelly. 

Image of stove in Skokie, IL location courtesy of Potbelly Corporation

Here's a legitimate bear case for Potbelly
Potbelly's recent same-store sales (just 0.7% for the fourth quarter) aren't yet a bear case, when compared to a bad weather stricken restaurant sector, but they aren't a good thing. Since a huge theme of the Potbelly bull is the opportunity for new store growth (there are currently about 300 Potbelly's), same store sales need to stay positive. 

To be clear, that doesn't mean that Potbelly needs to match Chipotle's 9.3% comparable sales growth (few, if any, will), it simply needs to meet 2012's figures, around 3.5%. 

So what's the real bear argument for Potbelly? I'll tell you what worries me most--CEO Aylwin Lewis. Mr. Lewis most recent experience includes stints as CEO at struggling retailers K-Mart and Sears.

While I would prefer a founder in a competitive business like this, I'd probably settle for a restaurant executive with a better recent track record of success. Despite his stint at Yum! Brands, I grew skeptical of Lewis after watching this interview with him following Potbelly's IPO. In the video, he seems to struggle recalling menu items (i.e. the ingredients in a "wreck" sandwich), and can't seem to mention any specifics about what Potbelly does. Lewis was put in place to help Potbelly gear up for its IPO, I'm not sure he has a passion for this particular business.

Once the big money leaves the room, and Potbelly shareholders are left with Lewis, it remains to be seen if he can deliver tasty returns. 

Foolish disclosure
While this article didn't discuss the bull case for Potbelly, I still should tell you I own a (very) small number of Potbelly shares. My shares were purchased about three weeks ago, as I've become interested in following the company. Potbelly was founded in my area, and has also been a lunchtime favorite of mine for about a decade.

But good sandwiches do not mean its a good stock. For sure, there is a solid bear case to made for Potbelly, it's just not the one you've heard most often.

Shareholders should identify the real bear cases for Potbelly and monitor them. Look at the CEO and same-store sales closely the next few quarters, they'll let you know where Potbelly is headed. 

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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 April 17, 2014, at 9:53 AM, FoolishQC wrote:

    Chipotle is way overvalued. Earnings miss and people are still dreaming here.

  • Report this Comment On April 17, 2014, at 10:36 AM, TheCommonTulip wrote:

    Hi FoolishQC. I respectfully disagree. Same-store sales were up over 13% for CMG in a quarter were weather stricken retaurants averaged less than 1% growth. It's tough to value that, and I wouldn't use stock price as a valuation tool.

    Food costs/inflation eating into bottom line earnings is likely temporary. Loyal fans driving ridiculous same-store sales is the key, in my humble opinion.

    Fool on!

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Adem Tahiri

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