Can Zoe's Kitchen Dodge Potbelly's Problems?

Potbelly crashed after reporting poor preliminary second-quarter results and took some other fast-casual chains along for the ride. However, one of the restaurants that dropped might not have the same problems.

Jul 18, 2014 at 5:00PM

While Potbelly (NASDAQ:PBPB) will officially report its final second-quarter results in August, it dashed investors' hopes with an earlier release on July 9. In the last two quarters, Potbelly blamed the weather, but that excuse won't fly this time. With a second quarter of negative comps expected and earnings estimates slashed, shares of the sandwich shop dived after hours on July 9 and continued lower on July 10. By the end of the day, Potbelly was down 25.1% and below its IPO price. Why did Potbelly suddenly cut its expectations so dramatically, and what does this announcement mean for other fast-casual chains - notably up-and-coming Zoe's Kitchen? 

Did the economy catch Potbelly off guard?
While Potbelly did note an impact from the timing of the Easter holiday, the comparable-store sales drop seems like it surprised management. Potbelly brought up its new flatbread sandwiches and its local marketing campaign, but it didn't go into great detail about what caused the miss. Revised data has shown that the US GDP dropped 2.9% in the first quarter, and this indicates that the economic climate may have been tougher than Potbelly expected. However, that didn't stop Chipotle (NYSE:CMG), Qdoba of Jack in the Box (NASDAQ:JACK), or Zoe's Kitchen (NYSE:ZOES) from posting comps growth in their most recent quarters.

Fast-casual chains can use pricing to their advantage in a weak economy and Potbelly's sandwiches are relatively inexpensive in comparison with food from other restaurants. An investor presentation in June showed that Potbelly sells its regular sandwiches for $4.70 and its big sandwiches for $5.70. These price points seem more comparable to those of fast food and quick service restaurants than those of other fast-casual chains. It doesn't seem like pricing is the problem here and economic weakness seems like it could help Potbelly attract customers from its peers.

The impact on the sector
Price movement on Thursday suggests that Potbelly's crash may have dragged down some of its peers as well. Most notably, Noodles & Company (NASDAQ:NDLS) was down 8% at the end of the day. Zoe's Kitchen also fell 3.1% on Thursday. While Qdoba does not have its own listing, Jack in the Box was still down 1.6%, which was a larger decline than that of the Dow at 0.4%. This might indicate some bearishness on Qdoba, but it's hard to tell because of its small size in comparison with the parent chain. Meanwhile, Chipotle dropped 0.6%, only a little more than the market.

Both Noodles & Company and Potbelly have recently blamed the weather for their problems, so it's not surprising that Noodles & Company saw the largest sympathy drop on this news. Noodles & Company also has earnings coming up in early August, and with this update from Potbelly it looks less likely that the noodle shop will see its sales bounce back because of better weather.

The opportunity
While Chipotle remains as popular as ever and Qdoba is in the middle of a nice turnaround, investors have been attracted to Potbelly and its peers because of the potential of picking up a restaurant chain earlier in its life-cycle. While Potbelly reiterated its plan to open a total of 40-48 restaurants this year in its second-quarter preview, investors really want to see high same-store sales growth and Potbelly might actually post negative comps for the year. If Noodles & Company can bounce back next quarter it could look promising in this regard, but now that Potbelly has shown that it has longer term problems Noodles & Company must show that it doesn't.

On the other hand, Zoe's Kitchen posted much better first-quarter results. On June 5, Zoe's Kitchen reported 5.7% same-store sales growth and no excuses.  While the geographic placement of Zoe's restaurants in the South insulated it from the bad weather that Potbelly and Noodles & Company used as an excuse, other potential issues such as the decline in first-quarter GDP did not drag its comps into the negative either. Zoe's Kitchen also expects 4%-6% same-store sales growth for the year, which exceeds the guidance of every peer mentioned here except for Chipotle. 

Foolish takeaway
While it wasn't a huge drop, it does look like Zoe's Kitchen was unfairly punished because of Potbelly's bad results. The forward guidance from Zoe's Kitchen also looks a lot better than that of the other fast-casual chains. While this guidance still came in below that of Chipotle, Zoe's Kitchen is still a very small chain with 120 restaurants as of its last report and a limited geographic reach and thus it has lots of expansion potential. This restaurant still looks like a good way to invest in the fast-casual trend.

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Eric Novinson owns shares of Zoe's Kitchen. 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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