Why Potbelly Has More Upside Than Noodles & Company
In 2012, 49% of all sandwiches consumed in America were bought at restaurants rather than made at home -- a 5% increase from 2010. Potbelly hopes to capitalize on this trend and the growing $20 billion U.S. sandwich industry. However, Potbelly is grouped into the fast-casual restaurant category and is often compared to Noodles & Company or Chipotle Mexican Grill -- primarily pasta and burrito chains, respectively.
A more accurate comparison for Potbelly is against the crowded sandwich industry that includes Firehouse Subs, Jimmy John's, Quiznos, Cosi, and the industry leader, Subway. Even though Noodles & Company is in a far less-crowded restaurant sector, Potbelly has more upside long term.
Potbelly's earnings debut had mixed results
Potbelly's initial earnings as a public company beat expectations both in revenue and earnings per share. Total revenue for the third quarter of 2013 increased 11.7% to $78 million, and EPS hit $0.15. Analysts had expected $77 million in revenue and EPS of just $0.09.
However, since then the stock has drifted back towards its 52-week low. While mostly positive overall, third-quarter earnings may have highlighted some areas of concern for shareholders.
As the company continues adding new locations, expenses will continue to rise. As a result, net income will likely decline. Net income for the first three quarters of 2013 was slightly less than $5 million compared to $5.5 million in the same period in 2012.
Additionally, comp sales rose 2.5%, but mostly as a result of the 3% increase in average checks due to menu-price increases. Non-comp sales (sales at newer locations) contributed 79.1% of the total revenue increase for the quarter. This may suggest that traffic is already near a saturation point at existing locations, foreshadowing a limit to long-term profit potential and that revenue increases going forward will be driven by new Potbelly restaurants.
Potbelly is not Cosi or Quiznos
2013 third-quarter earnings for Cosi revealed a bigger loss than the same quarter in 2012. The company, which had high expectations, has had only had two profitable quarters since going public in 2002. The Nasdaq has threatened to de-list the stock multiple times, and in 2013, the company had to enact a reverse split just to meet trading requirements. Cosi's problems have historically been the lack of net earnings and the ability to keep customers. High occupancy costs and an expensive menu also have hurt the chain for over a decade.
Similarly, Quiznos was once compared to Subway. However, Quiznos' debt is now at more than $600 million and the company has lost nearly 3,000 stores since 2008.
Quiznos has largely self-imploded due to a flawed supply chain. Franchisees have complained for years that Quiznos requires them to buy food and supplies from a Quiznos subsidiary. This has led to the subsidiary purposely charging higher prices to make larger profits. As a result, franchisees lose money, advertising is dropped, stores are closed, and debt continues to rise.
Potbelly is already producing net earnings and does not have the supply chain issues that Quiznos does.
Taking the Subwayto success
Industry competitors Firehouse Subs and Jimmy John's are profiting from sandwich trends and saw sales increases of 34% and 25%, respectively, in 2012.
However, Subway is the key to success for Potbelly. Subway has more than 41,000 locations worldwide with plans to add another 10,000 in the next four years. Annual revenue for the chain is $18.1 billion.
Subway's 100% franchise model may be its strongest point. Less than 1% of all revenue for Potbelly is from franchise royalties and fees. If Potbelly is able to expand more of its newer restaurants to franchisees and convert existing company-owned stores to franchises, it will allow the company to reduce expenses, increase the profit margin, and be more attractive to shareholders long term.
Potbelly has already added breakfast options -- something Subway successfully added to its menus in 2010.
A cloud around Noodles & Company after recent earnings?
Third-quarter earnings for Noodles & Company were later tainted by the announcement of primary and secondary offerings. The stock has fallen more than 18% since offering rumors started in mid-November 2013. Noodles & Company said the main purpose of the offering, 4.5 million shares priced at $39.50 per share, was to provide capital to repurchase Class A common stock from certain officers of the company. However, offerings like this often come years after an IPO, not months after.
Furthermore, Chipotle's ShopHouse SouthEast Asian Kitchen concept is slowly expanding similarly to how Chipotle itself expanded in the early 1990's -- in slow, calculated steps. The new concept follows Chipotle's ordering where you pick your own ingredients, and some items rival Noodles & Company's menu.
There are now six locations, up from just one in 2011, and there are plans to add more in 2014 .
The lack of direct competition may be more of a burden than a benefit for Noodles & Company. While Potbelly is able to use the congested sandwich industry to model what works and what doesn't, Noodles & Company is left to experiment on its own. This is costly and opens the door to sleeping giants like Chipotle that can easily invest excess capital into new restaurant concepts.
In the end, the upside for Potbelly over Noodles & Company may come down to menu simplicity. For a fast-casual chain, Noodles & Company has a relatively diverse and complicated menu. This comes at a price and one that will likely be paid for long term by the company itself.
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The article Why Potbelly Has More Upside Than Noodles & Company originally appeared on Fool.com.Michael Carter has no position in any stocks mentioned. 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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