Potbelly Needs to Change Its Story

Potbelly hasn't lived up to its pre-IPO hype of becoming the "next Chipotle."

Jul 18, 2014 at 9:23AM

Potbelly's (NASDAQ:PBPB) shares derailed last week, falling 25% as the sandwich maker pre-announced gloomy second quarter results and lowered its annual forecast. Potbelly surged 120% on its IPO, thanks to wishful hopes that it would become a "new" Chipotle Mexican Grill (NYSE:CMG), but it has delivered mostly bad news ever since.

Potbelly's stock price is near an all-time low. Here's what you need to know before you consider buying this "dip."


Source: Potbelly

Potbelly's management's glimmer of hope
Potbelly's stock sank because the restaurant chain pre-released weaker than expected second-quarter sales and earnings. Potbelly now expects to deliver negative same-store sales, down 1.6%, and a profit of 6 cents per share for its second quarter. The results are half of previous earnings expectations (12 cents per share), and revenue was guided down $3 million ($83.6 million vs. expectations of $86.7 million). 

Even worse was Potbelly's full-year guidance for 2014. Potbelly expects 2014 EPS between 18 cents to 21 cents. In May, Potbelly's management told investors it expected 2014 EPS to be 25-35% higher than 2013's total (0.34/share). Just two months later, somehow, that expectation has pulled a "180." 

So, is there any hope for Potbelly shareholders? Well, top-line sales for the quarter did rise 6.9%, but that's simply a result of revenues from new stores. Management said it still plans to open 40-48 stores this year, which may give some investors a glimmer of hope.

Something doesn't taste right
For some reason, Potbelly's growth story never adds up to me. Management is developing a track record of selling investors really great hopes that don't taste quite right. 

Just last week (before Potbelly's earnings release) I wrote that Potbelly's long-standing growth plan didn't make sense. The idea that any restaurant could expand rapidly, even though it has weak same-store sales, is unheard of. How can such a small chain plan to have net income growth of 20%, and new unit growth of 10%, with same-store sales only in the low single digits? It doesn't add up; it never has. With only 305 locations, Potbelly should have much higher demand at each of its existing stores. 

Moreover, I am troubled that management is still planning on opening 40-48 stores for the year. I thought this was a scary approach when Potbelly was guiding for comparable sales in the low single digits; it's an awful plan now that it's guiding comps either flat or slightly negative. When a management team opens new stores rapidly, even as demand in existing stores wanes, it seems reckless.

To avoid hyperbole, let me walk you through a useful example. Take a moment to digest Chipotle's most recent quarter.

  • Chipotle's revenue increased 24.4% 
  • Chipotle's same-store sales increased 13.4%
  • Net income rose 8.5%
Would it surprise you to know that Potbelly plans to expand (new stores) faster than Chipotle this year? Chipotle has over 1,600 locations and plans to add 180-195 stores, with comparable sales in the high single digits. It's a pretty aggressive expansion plan. Still, the low end of Chipotle's range would only represent new unit growth of 11% for the year; Potbelly's low end would represent 13% new unit growth for the year. 

Potbelly just told us that it now expects earnings and same-store sales to decline dramatically this year; should it still be expanding so rapidly? 

Potbelly needs a new story
This is a really great restaurant, with great food, and a tremendous atmosphere. It has a huge opportunity; sandwich shops hold 18% of the store count for all U.S. restaurants. Still, for some reason, customers aren't as keen on Potbelly as they once were. Management needs to forget its rapid growth story, and focus on what matters once again -- delighting customers. 

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