Should I Buy Potbelly Stock? 3 Pros, 3 Cons

In its first Potbelly earnings report as a public company, PBPB posted standout results

   

Potbelly (PBPB), which operates a chain of sandwich shops, went public back in early October, with PBPB stock skyrocketing 120%.

But that wasn’t the end of nice moves for Potbelly stock investors. In early trading today, Potbelly stock gained as much as 19% today.

PotbellyPromo Should I Buy Potbelly Stock? 3 Pros, 3 ConsThe reason? Well, Potbelly earnings were mouthwatering. For the third quarter, Potbelly earnings came to 15 cents a share and sales were $78 million. PBPB stock analysts had expected earnings of 9 cents per share and revenue of $77.9 million.

So are Potbelly earnings a sign that the company will continue its growth? Or should investors hold off on PBPB stock? To see, let’s take a look at the pros and cons:

Potbelly Stock Pros

Concept. PBPB got its start back in 1977 on Lincoln Avenue in Chicago. Potbelly had only one location until entrepreneur Bryant Keil bought the company in 1996 — and he wasted little time in expanding the operation. As of now, PBPB has a menu of toasty warm sandwiches and signature salads, which are all made fresh to order. Potbelly also has an assortment of cookies. To differentiate itself, PBPB allows each location to have its own design and local décor. There are even bands and musicians that play at least three times a week in a majority of the shops. The formula has certainly been a winner. According to a report from NPD Group, the average PBPB customer eats at a shop about two times every four-week period.

Growth Potential. There remains lots of runway left for PBPB — part of the reason Potbelly stock investors have been so bullish. Keep in mind that PBPB operates only 288 shops across 18 states and the District of Columbia. Going forward, the goal is to expand the base by about 10% per year. It helps that each location is a strong cash generator. The initial investment for PBPB is only about $600,000 but the profit margins reach about 25% within the first two years of operation.

Valuation. The price-to-earnings ratio does seem pricey for Potbelly stock, coming to about 26X. But this is normal for companies in the fast-casual market. After all, the category has experienced robust growth because of value-priced menus of quality items, which have been attractive for cash-strapped consumers. In fact, on a relative basis, Potbelly stock does look cheap. Consider that Chipotle Mexican Grill’s (CMG) multiple is 54X and Noodles (NDLS) is trading at a nosebleed 398X.

Potbelly Stock Cons

Competition. PBPB has to deal with major direct competitors like Subway, Jason’s Deli and Quiznos. And of course, there are many local mom-and-mom shops to compete with Potbelly. It’s not hard to setup a sandwich shop. And on a broader scale, PBPB must compete against many of the quality options that consumers have, such as from fast-casual players like Chipotle and Panera Bread (PNRA).

Geographic Concentration. Nearly 70% of PBPB locations are in Illinois, Texas, Washington, D.C., Michigan, Minnesota and Ohio. In fact, the Chicago metropolitan area accounts for about 27% of sales! While this type of concentration is normal for an early-stage company, there are risks for Potbelly stock. An regional downturn could have a disproportionate impact on operations. Another issue is that, as PBPB expands beyond its core areas, it far from clear if its concept will resonate with customers.

Franchise Program. PBPB started this in 2010, with the initial focus in the Middle East. No doubt, franchising can be a cost-effective way to help accelerate growth, as seen with companies like Domino’s Pizza (DPZ) and Dunkin’ Brands Group (DNKN). But the strategy can be tough to manage. There is limited control over the operations of the franchisees and quality can suffer. This could damage the brand and customer perception of Potbelly — which has been a key driver of growth and PBPB stock.

Verdict on Potbelly Stock

As seen with the latest Potbelly earnings report, PBPB seems to have few problems keeping up its growth ramp. During the period, revenues jumped by about 12%.

Plus, there is much room left for Potbelly to grow. And with access to capital from its IPO, PBPB can continue to build out new stores, which have a solid history of quick profitability. All in all, the company has been disciplined with its growth strategy.

So should you buy Potbelly stock? Yes — if you’re looking to play the growth trend in the fast-casual market segment, the pros certainly outweigh the cons for PBPB stock.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO StrategiesAll About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.


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