Is It Time to Get Long on Potbelly?

Are Potbelly's two consecutive quarters of comparable sales declines a reason to worry, or has it created an opportunity for long-term investors?

Jul 14, 2014 at 3:04PM

Potbelly (NASDAQ:PBPB) shares have found a new low after a second- quarter warning sent shares crashing more than 20%. Potbelly most certainly has not enjoyed the same stock performance of peers Zoe's Kitchen (NYSE:ZOES) and Chipotle Mexican Grill (NYSE:CMG), but following its dire outlook and stock performance, what's the company doing wrong? Is there investment value from this point forward?

What's wrong with Potbelly?
In the restaurant sector, fast-casual chains have been among the only companies to have grown in this macro environment, and like Zoe's and Potbelly, many have tried to replicate the success of Chipotle with this business model.

The fundamental problem for Potbelly is competition: The company sells sub sandwiches as its primary offering. This means it has to compete with the likes of Subway, Quiznos, and Jimmy Johns, among others. Notably, these competitors naturally operate as fast-casual restaurants of sorts.

Meanwhile, Chipotle's Mexican Grill and Zoe's Mediterranean cuisines, respectively, are typically categorized as either fast-food or dine-in, making the fast-casual model rather successful -- especially for Chipotle, given the fact that it was the first to successfully execute this approach.

Let's dig deeper into the numbers
There is perhaps no better proof of Potbelly's operational woes than its recent fundamental outlook.

According to Potbelly, company-owned comparable-store sales will decline 1.6% in the second quarter. Given its 2.2% decline in comparable sales during the first quarter, the company now expects flat-to-negative low single-digit comparable sales for the year.

In other words, with slightly more than 300 total stores and $304 million of 12-month revenue, Potbelly's ability to grow existing stores appears to have reached a peak. Granted, this doesn't mean that total revenue won't grow, but looking ahead its year-over-year revenue performance will likely be dictated by its ability to expand store count.

With that said, investors pay close attention to comparable-store sales for restaurants. When rising it often suggests improved margins and is a good sign of sustainable growth. But, as previously mentioned, Potbelly's competition makes it very difficult for the company to find an edge in this business...or to become the next Chipotle-like company.

A better option
So far Potbelly has lost more than half its valuation in 2014, meaning some investors might try to catch this falling knife. However, while more expensive, Zoe's Kitchen and Chipotle remain far better investment options.

In Zoe's last quarter it grew revenue by 47.4% year over year, although its comparable sales increased just 5.7%. Clearly, Zoe's comparable sales are significantly outpacing Potbelly's, but it also has expansion opportunities with only 120 total stores.

For Potbelly, with more than 300 stores, expanding becomes much more difficult as it must compete with a Subway or Quiznos on every corner. But in the Mediterranean space, the market's there for the taking.

In regard to Chipotle, with 1,637 stores some might think it's approaching peak potential. However, this is a company that grew revenue 24.4% and comparable sales by a whopping 13.4% in its last quarter.

Also, Chipotle still has significant vertical and horizontal growth opportunities. This includes more than 180 new stores in 2014, global expansion beyond North America, new restaurant concepts like fast-casual pizza, and new menu items and categories. Given its success and ability to drive double-digit comparable sales growth, investors have to like the company's opportunity to grow significantly larger long term.

Foolish thoughts
Chipotle and Zoe's are two different sized companies, both with growth opportunities and competitive advantages. Potbelly does not have the same opportunity or advantage. This is being seen in the company's comparable sales and in its difficulty to produce growth. Hence, it's no surprise that Potbelly's post-IPO performance has been so challenged, and in looking ahead, it's hard to say that anything will change.

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Brian Nichols owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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