Since a hard charge out of the IPO gate last year with a strong rise in its stock price on its first trading day, it has seemingly been all downhill for fast casual restaurant chain Potbelly (NASDAQ: PBPB), including a sharp share price drop in 2014. The company has been hurt by slowing top-line growth, due to a comparable store sales performance that has turned negative in FY2014, a trend that has also affected some of its competitors, like Noodles & Co. (NASDAQ: NDLS).
As illustrated in the below table, Potbelly's slowing top-line growth has clearly impacted investor expectations for the company, which has resulted in Potbelly's shares being valued at a declining price multiple. However, at its discounted price, is Potbelly finally a good bet?
Market Cap. @ Qtr. End
|2Q2014||$84 M||(1.6)%||$470 M||1.5|
|1Q2014||$74 M||(2.2)%||$521 M||1.7|
Source: Potbelly 2013 10K Report, 1Q2014 10Q Report, 2Q2014 10Q Report
What's the value?
Potbelly is an up-and-coming 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 consistent annual top-line growth, up roughly 40% over the past four fiscal years. More importantly, the higher sales tallies combined with a more efficient store base have led to better cash flow generation, funding an expansion of Potbelly's store network into new markets, including recent moves into the Boston and New York City metro areas.
In its latest fiscal year, Potbelly continued building upon its long-term growth trajectory, reporting a 9.0% increase in total revenues that was a function of a double-digit expansion of its store base and a 1.5% increase in comparable store sales, 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 impacted its occupancy costs, leading to a 50 basis point contraction in its average store profitability. However, Potbelly was able to offset the negative impact through cost efficiencies in its corporate overhead, culminating in slightly higher adjusted operating profitability for the period and an 11.3% gain in operating income.
Looking into the crystal ball
Unfortunately, Potbelly's financial performance has soured a bit in FY2014, due to a 1.9% decline in comparable store sales that has reduced the productivity of its stores, evidenced by a 160 basis point decrease in its average store profitability. While the company benefited from some relief in commodity prices during the period, it was hurt by relatively higher occupancy and marketing costs, the latter due to a need to stand out in an increasingly crowded fast casual space. Worse, Potbelly's weak financial trends forced management to reduce its FY2014 profit outlook for the company back in July, a decision that led to a steep subsequent selloff in its share price.
Of course, Potbelly isn't alone in its profit growth challenges, as competitor Noodles & Co. has also been struggling to meet high growth expectations lately, reporting a 1.1% decline in comparable store sales in FY2014, its first negative sales comp performance since FY2009. While the company reported a slight gain in adjusted operating income during the period, its adjusted operating margin declined, down 90 basis points, partially due to a strategic move into higher-cost markets, including San Francisco and Philadelphia. The net result for Noodles & Co. was a slide in its cash flow generation, below its level of capital expenditure spending, bringing into question its ability to continue growing its store base at a double-digit rate.
Indeed, Chipotle Mexican Grill (NYSE: CMG) is one of the few industry players that seems to have been able to sidestep a sales slowdown in 2014, evidenced by a 26.6% top-line gain in FY2014 that benefited from higher customer traffic volumes and better average pricing. While the company was negatively impacted by rising commodity prices, especially for avocados and beef, an increase in productivity at its stores allowed Chipotle to continue reporting strong growth in operating income, up 18.4% for the period. More importantly, the company's rising popularity is providing cover 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 is undoubtedly cheaper than it was at the start of the year after a more than 40% decline in the price of its shares. On the other hand, the negative price action seems warranted, given that management is currently forecasting adjusted EPS for the current year of $.18 to $.21, a roughly 43% decline from the level achieved in FY2013. More importantly, Potbelly is trading at a forward P/E multiple of approximately 62, an anecdotally pricey level for a company that is only growing its top-line at a single-digit rate. As such, Potbelly is not much of a deal at its current price and investors should probably avoid it.
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