Has Potbelly Gone Rotten?

Source: Potbelly

After reporting preliminary revenue and earnings results for the second quarter of its 2014 fiscal year on July 9, Potbelly (NASDAQ: PBPB  ) shed 25% of its market cap. With shares of the fast-casual chain down 68% from their 52-week high, some investors are probably wondering if now might be the best time to jump into the stew. But is it possible that a rival like Noodles & Company (NASDAQ: NDLS  ) could make for a far tastier bite?

Potbelly severely disappointed!
For the quarter, Potbelly reported that it expects to see revenue of $83.6 million. Although this represents solid  7% growth compared to the $78.2 million management reported for the second quarter of 2013, the company's top line will come in below the $86 million Mr. Market hoped to see.

According to the company's press release, this increase in sales stemmed from an increase in its number of locations in operation from 280 in June 2013 to more than 300 today. This was, however, somewhat offset by a 1.6% drop in comparable-store sales.

  Last Year's Forecast Actual
Revenue $78.2 million $86 million $83.6 million
Earnings per Share (adjusted) N/A (not yet public) $0.10 $0.06

Source: Yahoo! Finance and Potbelly

From a profit standpoint, the company did even worse. If management's expectations come to fruition, Potbelly will report adjusted (non-generally accepted accounting principles) earnings per share of $0.06. This will represent a 40% decline from the $0.10 analysts previously expected and will mostly be due to a $400,000 increase in advertising expenses and a $800,000 jump in stock-based compensation.

Is Noodles & Company any better?
The past three years have been particularly mixed for Potbelly. Between 2011 and 2013, the restaurant chain reported a 26% rise in revenue from $238 million to $299.7 million. This rise in sales has been driven, in part, by a 26% increase in the number of locations in operation from 234 in 2011 to 296 by the end of the business' 2013 fiscal year; but it was also attributable to an aggregate comparable-store sales improvement of 7%.

PBPB Revenue (Annual) Chart

Potbelly Revenue (Annual) data by YCharts

Over the same three-year period, rival Noodles & Company did even better. Between 2011 and 2013, the company saw its revenue shoot up 37% from $256.1 million to $350.9 million. Like Potbelly, Noodles & Company benefited from a jump in store count, which soared 34% from 284 locations to 380 (including its franchised operations), but the company also enjoyed a hefty 14% jump in aggregate comparable-store sales.

Source: Potbelly

Looking at profitability, Noodles & Company continued to outpace Potbelly. Over the past three years, the company's net income skyrocketed 76% from $3.8 million to $6.7 million. While a good portion of this increase can be chalked up to the chain's revenue growth, the rest was due to a decrease in Noodles & Company's interest expense, which fell from 2.4% of sales to 0.6%.

PBPB Net Income (Annual) Chart

Potbelly Net Income (Annual) data by YCharts

Potbelly, on the other hand, hasn't been so lucky. During the same time frame, the fast-casual chain's net income plummeted 82% from $7.2 million to $1.3 million. Despite benefiting from higher sales, an increase in the business' cost of goods sold from 78.2% of sales to 79.4% -- and a jump in its selling, general, and administrative expenses from 11.9% of sales to 13.7% -- had a significant negative impact on its bottom line.

Foolish takeaway
Given its poor performance for the quarter, it makes sense that Mr. Market would feel disenchanted with Potbelly. In addition to falling short on both the upside and the downside in the short run, an outlook consisting of flat-to-negative comparable-store sales growth for the rest of the year and a mediocre operating performance in recent years have investors wondering if the company is worth it. While it is possible that business may pick up, the Foolish investor who's interested in a faster-growing prospect might consider Noodles & Company, a business with a better long-term track record.

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