With Its Momentum Gone, Is Potbelly Finally a Good Bet?

Shareholders of restaurant chain Potbelly were not smiling after the company's latest financial update led to a sharp drop in the company's share price. After the big drop, though, is it time to buy in?

Jul 17, 2014 at 11:00AM

Pbpb

Source: Potbelly

Since its hard charge out of the IPO gate when its stock price more than doubled on its first trading day, it has been all downhill for fast-casual restaurant chain Potbelly (NASDAQ:PBPB), as its price has declined 60% since then. The company has anecdotally been hurt by unrealistic growth expectations, no doubt due in part to comparisons with segment leader Chipotle Mexican Grill (NYSE:CMG), a company that seems to be in a category of one.

A case in point was Potbelly's latest financial update, where it pre-announced worse-than-expected financial results for its fiscal second quarter; this revelation led to a bloodbath for its stock price, which subsequently dropped by a double-digit percentage. However, with management sticking to its new store growth plans despite the business challenges, could the company be a good bet at its current price?

What's the value?
Potbelly is a rising player in the fast-casual segment of the restaurant business, operating a network of more than 300 stores with a heavy concentration in its home market of metro Chicago. The company has ridden the increasing popularity of its trademark oven-baked sandwiches and homemade cookies to solid top-line growth of roughly 40% over the past four fiscal years. More importantly, the higher sales tallies have led to higher operating cash flow that has funded an expansion of Potbelly's store base into new markets, including recent moves into the Boston and New York City metro areas.

In its latest fiscal year, Potbelly continued to build upon its long-term growth trajectory. It reported a 9% increase in total revenue that was a function of an expansion of its store base and a modest pickup in its comparable-store sales, where it reported its fourth straight year of growth. On the downside, though, the company was hurt by its current focus on increasing its presence in higher-cost urban markets, which adversely affected its occupancy costs. The net result for Potbelly was a sizable drop in its operating profitability, highlighted by a double-digit decline in its adjusted operating income.

Looking into the crystal ball
The question for investors is: When will Potbelly start to deliver the consistent profit growth necessary to provide a solid foundation for a higher market valuation? Unfortunately, that seems unlikely to happen anytime soon, given that management just reduced its profitability outlook for the current fiscal year.

Of course, Potbelly isn't alone in its profit growth challenges, as competitor Noodles & Co. (NASDAQ:NDLS) has also been struggling to meet high expectations, which most certainly caused its roughly 15% stock price slide in 2014. While the company reported a slight gain in adjusted operating income in its latest fiscal quarter of 2.4%, its operating margin declined during the period, partially due to its first negative comparable-store sales performance since the third quarter of fiscal 2009. In addition, much like Potbelly, Noodles & Co.'s profitability was negatively affected by its strategic move into higher-cost markets, including San Francisco and Philadelphia.

Indeed, Chipotle is the only company that seems to have been able to sidestep the industry slowdown in 2014, evidenced by a 24.4% top-line gain in its latest fiscal quarter that benefited from higher customer traffic volumes. While the company was negatively affected by rising commodity prices, especially for avocados and beef, an increase in productivity at its stores allowed Chipotle to report a double-digit increase in operating income. More importantly, the company's popularity is providing cover for it to raise prices for the first time in three years, a move that should keep its profit growth trending in a positive direction.

The bottom line
Potbelly's latest financial update was clearly not what Mr. Market was looking for, judging by the subsequent decline in the company's stock price. That being said, Potbelly now looks like an emerging value story, with a current price to adjusted EBITDA of roughly 14 compared to roughly 19 for Noodles & Co, based on each companies' last fiscal year adjusted EBITDA. 

In addition, the company is a potential margin expansion story, given that its current corporate infrastructure can likely support much more than the 300 or so current stores.  The key for Potbelly, like with most retailers, is comparable store sales increases, one of the key ingredients for improved operating profitability and sustainable profit growth. 

While investors should keep the company on the back burner for the time being, once Potbelly's sales comps turn positive again, they should definitely be buyers.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Robert Hanley has no position in any stocks mentioned. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers