The frenzy that surrounds popular IPO's can leave many investors wondering if the listed stock could be the next (insert wildly successful competitor name. In this case, insert "Chipotle"). Concerns also gravitate toward whether or not investors are getting a good deal. There is reason to believe that Potbelly Corporation (PBPB +0.00%) shouldn't be pegged with the grossly overvalued moniker. Shares are certainly not whetting the appetite for value investors at 2.5x sales, but they are currently being fairly valued when accounting for fundamental performance that mirrors peers such as Dunkin' Brands Group, Panera Bread Company, (NASDAQ: PNRA), Starbucks Corporation, Noodles & Company, (NASDAQ: NDLS) and Chipotle Mexican Grill (NYSE: CMG) .
Fast-casual and fast-food restaurants, while different in their menu offerings, are ultimately very similar when it comes to valuation. Store expansion and store-level operating profitability, in addition to same store sales, primarily determine what valuation the market places on shares. Potbelly's is besting or in line with its competitors for store expansion and store-level operating margins, although the company is recently underperforming on a same store sales basis.
Potbelly store expansion in line with the industry
The company currently has 280 stores in 18 states and is growing its store count at an annualized rate of 8.7%. In its S1 filing, management commented on plans to ramp up store expansion to 10% annually. Comparing other chains in such expansionary phases, Potbelly is matching the industry which has averaged 9.1% annually. Dunkin Brands, Panera and Starbucks are expanding slower and store counts have increased annually by 3.6%, 6.1% and 5.4%, respectively, since 2010. Only Noodles & Company and Chipotle Mexican Grill are outpacing peers at 13.7% and 17.2%, respectively.
(Annualized store growth rates from CY10-CY13 per company SEC filings 10K and 10Q, P/S current peer average for tickers CMG, DNKN, SBUX, PNRA, NDLS and PBPB)
Store-level operating profitability supports store growth
Potbelly isn't falling short on store-level profitability either. In the most recent quarter, the company reported store-level operating margins of 20.9%. Operating margins north of 20% generally indicate good store-level performance in the fast-casual/fast-food industry with Chipotle leading peers at 26.7%. Accordingly, store expansion is likely to continue because simply stated, expansion makes sense when a company can achieve an acceptable return on its investment. As long as margins remain high, management will deploy capital for continued store growth.
Same store sales lagging the industry
Potbelly has averaged same store sales of 2.2% since 2010 while peers delivered 4.8%. Lower relative same store growth is a contributing factor to why Potbelly shares are trading at a 40% discount to peers on a P/S basis.
Closing thoughts
Let's be honest, Potbelly currently is no Chipotle, and valuations are appropriately reflecting that. It remains to be seen if the company, or any competitor for that matter, can perform to Chipotle's level. If Potbelly's customers end up finding value in its neighborhood branded approach with higher quality sandwiches, then increased brand awareness will boost same store sales ahead of the industry as its footprint increases nationally. For those who believe management can execute on this strategy, I'd argue shares are undervalued today. Unfortunately, until proof of concept is achieved on a broader scale, Potbelly shares are being fairly valued by the market as the company has yet to step up and compete in the fast-casual space.
