Why You Shouldn’t Give Up on Potbelly Corp Just Yet

Potbelly (NASDAQ: PBPB  ) has lost over 37% of its stock price this year and has been cut by more than half since its IPO in October of last year.

Potbelly is often criticized for lacking product differentiation among the dozens of nationwide sandwich chains, and is frequently compared to Panera Bread (NASDAQ: PNRA  )  because of its menu. It's also compared to Chipotle Mexican Grill (NYSE: CMG  ) because it's considered a fast casual chain.

Even though Potbelly has struggled so far and appears to still be overvalued by commonly used metrics, there are several reasons why you shouldn't give up on it.

Credit: Michael Carter.

Potbelly's  recent earnings vs the competition
First quarter earnings for Potbelly showed revenue increased 7.5% to $73.9 million. The company reported a net loss of $0.01 per share, which was a huge improvement over the $1.74 per share loss in the same quarter a year ago. However, a large $7.4 million write down last year skews the comparison.

Panera Bread's first quarter showed a revenue increase of 8% to $605 million. However, earnings took a huge hit from its Panera 2.0 expenses and net income fell 12% to $42 million. Panera 2.0 is its new end-to-end system that enhances customer service for ordering and payments, which include new in-café kiosks, a new website, and a new mobile ordering app.

Both Potbelly and Panera Bread were hurt by bad weather as comp sales fell 2.2% and 0.1%, respectively.

First quarter revenue for Chipotle soared 24.4% to $904.2 million as net income rose 8.5% to $83.1 million. Despite increased traffic and average checks, which resulted in comp sales up an impressive 13.4%, Chipotle disappointed the market with news of higher commodity costs. As a result, the chain announced plans to raise menu prices for the first time in three years.

Compared to Panera and Chipotle, Potbelly looks like the kid looking for a seat while playing musical chairs. However, in recent weeks, Potbelly looks like it is still able to play.

Potbelly's upside potential
Things got a lot more interesting for Potbelly regarding expansion plans. Company officials in March said they were targeting Oklahoma City as the next franchise market. However, in its recent conference call the newest hub city was decided to be Denver, Colorado with five shops planned in the city this year.

There are two reasons why this is important. First, Denver happens to be the location of the first Chipotle restaurant and is Chipotle's current headquarters. Could Potbelly be betting on lightning striking twice by going where the most successful fast casual chain began? Second, something must have occurred that pulled Potbelly out of Oklahoma City and into another area of the country.

Credit: Potbelly. Colorado (in red) is now Potbelly's newly chosen hub market for 2014.  

Subway recently announced it has room to add up to 8,000 more locations in the U.S. alone. This will add to its 26,600 locations in the U.S. and 41,700 total locations worldwide. Some feel Subway's growth goal equals Potbelly's growth potential.

Despite disappointing results, Potbelly is making moves to improve. It introduced a mobile app in March that allows customers to locate stores and make orders. Potbelly also has plans to introduce a new flatbread. Even though Panera is introducing a new flatbread offering (with three flavors to Potbelly's one), the fact that Potbelly is introducing new menu items is a huge plus.

Food costs actually fell for Potbelly in the first quarter. Both Panera and Chipotle saw their food costs go up. Chipotle's food, beverage, and packaging costs actually jumped over 30% in the first quarter, outpacing revenue growth.

Credit: Potbelly. Potbelly's food costs declined in the first quarter of 2014.

Lastly, Potbelly appears to have an edge over Panera when it comes to catering growth. Panera reported that catering growth over the past year has flattened. However, Potbelly said its catering segment is one of the fastest parts of its business and that it is focused on expanding its catering ecosystem this year.

Possible problems with Potbelly's stock
There is no getting around that Potbelly is overvalued by traditional metrics. It currently trades at over 50 times this year's earnings. That's Chipotle territory, but Potbelly hasn't been able to match its outperformance thus far.

In fact, Potbelly seems to be regressing a little. Weather was blamed for the past two quarters of poor same-store sales. However, if you look at previous winter reports, the company has performed much better. For example, just two years ago comp sales were up 6.4%.

Bottom line
It is said when a stock starts to fall (like Potbelly has in a relatively short time), you shouldn't try to catch a falling knife.

Yet, Potbelly has a lot of upside and with just 317 total stores, it has a much smaller footprint than Panera's 1,800 locations and Chipotle's 1,637 locations. Unlike the tech sector where a winner-take-all market can erase companies overnight, there is always room for new concepts in the restaurant industry.

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