Potbelly Corp. Shares Are Getting Walloped for a Very Good Reason
Potbelly Corp. shares debuted to great fanfare last fall. Potbelly expected to sell shares for $12 to $13, but its IPO priced them at $14 -- and shares exploded to more than $30 soon after public trading began. Since then, the company has been on a long march downward. On Thursday, shares plummeted more than 20%, dropping below $11 for the first time.
What happened? To put it very simply, Potbelly investors are finally coming to grips with the fact that they haven't found the next Chipotle Mexican Grill . Despite its size, Chipotle has consistently posted strong comparable-store sales growth. By contrast, Potbelly is struggling to get more customers in the door.
Weak trends to begin the year
In May, Potbelly announced that Q1 company-owned comparable-store sales declined 2.2%. As a result, the company reported a small loss, compared to a small profit in Q1 2013. CEO Aylwin Lewis described this performance as "satisfactory," blaming bad winter weather for reducing comparable-store sales by 375 basis points.
This performance looks a whole lot less satisfactory when compared to Chipotle Mexican Grill's dominant first quarter. Chipotle's comparable restaurant sales soared 13.4% in Q1 due to strong traffic and increases in throughput. While it's true that Chipotle is more geographically diversified than Potbelly, that doesn't come close to explaining the gap in performance.
Potbelly drops its guidance
As it happens, there was more to Potbelly's sluggish Q1 sales trend than bad weather. On Wednesday afternoon, Potbelly revised its Q2 guidance downward, catalyzing its most recent stock slide. For Q2, comparable-store sales declined 1.6%. This will result in net income of approximately $2.0 million, down from the $2.8 million it earned in Q2 2013.
For the full year, Potbelly now expects comparable-store sales to be flat or down slightly -- it previously expected low-single-digit growth. It expects adjusted EPS of $0.18 to $0.21 in 2014. That's way down from the adjusted EPS of $0.34 that Potbelly posted in 2013 and well below the average analyst estimate for EPS of $0.31 in 2014.
By contrast, Chipotle Mexican Grill is likely to maintain its strong sales trends throughout 2014. Chipotle recently raised its menu prices, which is likely to keep comparable-restaurant sales growth in double-digit territory for the full year. Analysts currently expect Chipotle to grow earnings by about 20% this year.
Potbelly can grow, but will it be profitable?
Chipotle has demonstrated over the past decade that it can generate very strong profit margins. Potbelly bulls have been hoping for similar results, but without any luck so far. Potbelly's profit margin has been mired in the low single digits.
Like Chipotle, Potbelly has great growth potential: The company believes it could eventually operate at least 1,000 shops in the U.S., up from 330 at the end of March. However, unless it can boost its profit margin, what's the point?
Growth may allow Potbelly to leverage some corporate overhead, but that only goes so far. With stagnant comparable-store sales trends, Potbelly won't be able to expand its profit margin very far. Considering that Potbelly still trades for more than 50 times its new 2014 EPS guidance, shares could fall further unless Potbelly manages to jump-start growth.
Foolish bottom line
Potbelly Corp. has benefited from the market's appetite for fast-casual restaurant stocks. It has received a Chipotle-like earnings multiple based upon its long-term growth potential. However, Potbelly hasn't been able to deliver the goods.
Whereas Chipotle consistently generates strong comparable-store sales growth -- driving long-term margin expansion -- Potbelly is already struggling to increase comparable-store sales. Until it regains some momentum there, investors should probably stay away.
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The article Potbelly Corp. Shares Are Getting Walloped for a Very Good Reason originally appeared on Fool.com.Adam Levine-Weinberg owns shares of Chipotle Mexican Grill. The Motley Fool recommends and 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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