When sandwich chain Potbelly Corp. (ticker: PBPB) held its initial public offering nearly three years ago, you would have thought the next big fast-casual restaurant stock had hit the market. Within minutes of listing at $14 a share, the stock more than doubled. The next trading day, it surpassed $32.
Since that day, it has yet to come close to its peak again.
Potbelly shares fell nearly 58 percent while the company struggled to keep in-store performance surging even as expansion plans moved forward. It’s now below its IPO price, sitting near $13 a share.
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But investors saw a ray of light this year, as PBPB’s results finally seemed to turn the corner. With the company up over 10 percent in 2016, it has Wall Street wondering if this momentum can continue. However, it’s not just Potbelly’s strategy that has analysts remaining nervous; the economy plays a role as well.
Here are a few things to consider before biting off a piece of Potbelly.
Sales growth at established stores finally see a boost. Potbelly’s fall was exacerbated once its comparable store sales — or sales from companies opened 15 months or longer — began to show significantly slower growth. In 2012, comparable store sales grew 3.4 percent, which was followed by a 1.5 percent boost in 2013 and just 0.1 percent increase in 2014.
With this number declining, investors “question the long-term opportunity,” of Potbelly’s offering, says Piper Jaffray analyst Nicole Miller Regan. And for an expanding, regional chain, opportunity is what investors want.
One reason the sales numbers suffered was because the management team, besides the CEO, wasn’t stable, adds Regan. This left it unclear how strategies would change and a lack of focus on where Potbelly would target as its next growth area.
But from 2014 to mid-2015, CEO Aylwin Lewis hired a new chief financial officer, head of operations, general counselor and head of human resources. This has created a “stable management team over the past year,” Regan adds. With stability, Potbelly has improved selection of new restaurants and promotions — like a successful launch of avocado as a topping.
This has also turned around comparable store sales, which jumped 3.7 percent and 1.7 percent, in the first and second quarter of 2016.
Potbelly operates most of its locations, for better or worse. While it’s not entirely fair to describe Potbelly as a regional chain — it has a large presence in Chicago, as well as the District of Columbia, for example — it still hasn’t established a national footprint. It’s working to grow its market, which is one reason why the IPO shot up so quickly — people thought it could expand faster.
With more than 400 stores, “management sees long-term potential for at least 1,000 domestic locations,” says Robert W. Baird analyst David Tarantino, “and we think 1,500 to 2,000 locations may be possible over time.”
But Potbelly owns and operates about 90 percent of its stores. While it has 39 franchise-operated locations, it relies on its own financing to grow its presence. This can boost revenues much faster, since Potbelly doesn’t just collect fees from franchisees; revenues jumped 15 percent last year.
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Because the company doesn’t just collect fees, though, it also leaves it more susceptible to short-term changes in consumer spending. And, since it also primarily serves the urban lunch crowd, it’s in a highly competitive space, pitting Potbelly against places like Chipotle Mexican Grill (CMG), Panera Bread Co. (PNRA) and local options.
To stand out, it’s updating its mobile application in order to encourage more deliveries, which Regan is optimistic about.
“Some items deliver better than others. Soup, salad, sandwich — it’s a winning combination for that,” she says.
Fast-casual restaurants remain a booming business. Potbelly is positioned in one of the fastest groups of restaurant growth — the fast-casual model. Limited-service restaurant sales grew 5.5 percent last year, compared to 3.6 percent for full-service restaurants, according to Technomic.
Also, the fast-casual space was hit by a drastic change late last year, when Chipotle suffered an E. coli crisis. Customers were left unsure about the safety of the food, which stretched on for months and continues to hurt the franchise. Comparable restaurant sales for Chipotle fell 23.6 percent in the second quarter alone.
While Chipotle struggles to regain the trust of its customers, other lunch spots benefit, including Potbelly. The only problem is, the impact of those fleeting sales from Chipotle hasn’t moved into one type of restaurant or toward one name.
“I don’t think any one concept saw a benefit more than another,” Regan says. “It spread pretty wide across the industry.”
While Potbelly could see incremental improvement, if customers continue to stay away from Chipotle, it isn’t something to focus on as an investor.
Base your valuation on how you view the industry. Potbelly’s price looks like a deal or appears pricey, depending on how you feel about the industry as a whole and whether the growth efforts are enough. William Blair analyst Sharon Zackfia prices Potbelly at 7.2 times enterprise value to earnings, once things like taxes, interest and depreciation are added back in, which is 50 percent below the restaurant’s peers. And the company has “relatively undemanding long-term targets,” she adds.
Regan, who prices it similarly, is less optimistic about Potbelly’s situation since, even with a 10 percent growth in stores, it’s very much tied to lunch spending, which can shift faster than it takes to order a sandwich.
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Either way, investors are no longer fleeing this newbie stock, which implies it’s at least, once again, worth watching.
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4 Things to Know Before Buying Potbelly originally appeared on usnews.com
