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Takeaway: PBPB remains on the Hedgeye Best Ideas list as a SHORT

RECAP

PBPB reported 4Q13 results yesterday after the close.  While adjusted EPS of $0.06 beat expectations of $0.04, it was well below last year’s adjusted EPS of $0.12 which included an extra operating week.  Total revenues of $74.761m came in 168 bps light of expectations as the company delivered meager year-over-year comp growth of 0.7% on an adjusted basis.

PICKING UP WHERE IT LEFT OFF

It was a disappointing 4Q13, due in part to circumstantial situations as the company was hampered by the two-week government shutdown in October and extraordinarily poor weather in December.  Typically, we would chalk these up as nothing but excuses, but the geographic profile of PBPB suggests we should give the company the benefit of the doubt.  After all, Potbelly has over 70% of its stores in the Northeast/Midwest.  This lack of geographical diversification is part of what makes us cautious on the name (significant exposure to external events, unproven in other markets), but we’ll save that for another time.

Considering this exposure and the inability to protect against it, management estimates that weather had a 310 bps impact on December comps and believes the negative impact to-date in 1Q is even worse.  All told, 1Q14 is shaping up to be a disaster and could pressure the full-year outlook.  Consensus is currently looking for 1.8% comp growth in 1Q14 – we suspect this will come down, a lot.  Management has not come off its original 2014 estimates, which means they are expecting the next ten months to overcompensate for the past two.  In reality, PBPB hasn’t grown traffic for at least the last four quarters (by our estimates) and is generating EPS growth primarily from unit growth.  Management’s comp guidance implies that they believe they have the ability to take price to drive average check higher, but relying on price to drive future profitability is a fool’s errand.  With declining traffic trends, this becomes an even riskier proposition.

PBPB LAYS AN EGG - pbpb sss

PBPB REMAINS A CORE SHORT

Management provided the following 2014 full-year guidance on the 4Q13 earnings call.

2014 FULL-YEAR GUIDANCE

  • Adjusted net income growth between 25-35%
  • 35-40 new company shops including at least one new hub market
  • 5-8 new franchise shops
  • Low single-digit comparable sales growth driven by both check and traffic
  • Effective tax rate below 39.5%
  • Capex of $30-35m
  • Shares outstanding between 30-32m shares

Maintaining full-year guidance after a tumultuous start to the year seems a little aggressive to us and, if the current estimates stand, it could be difficult for PBPB to hit the numbers.  Aside from our issue with the low quality comp growth, from a growth (?) concept, we are also discouraged by a complete lack of consistent AUV growth.

PBPB LAYS AN EGG - pbpb auv

Maybe the underlying numbers will begin to improve with more reasonable weather, but the fact of the matter is, by our estimates, Potbelly hasn’t grown traffic for over a year.  Assuming the numbers begin to normalize, we still believe estimates are too aggressive.  The street is currently looking for total revenue growth of 11% on the back of a 1.9% comp.  For this to happen, Potbelly will likely need to see sustained traffic growth throughout the remainder of 2014.

Management reiterated the following long-term guidance on the 4Q13 earnings call. 

REITERATE LONG-TERM GROWTH TARGETS

  • Total new shop growth of at least 10%
  • Low single-digit comparable sales growth
  • Annual adjusted EBITDA growth of 20% or more
  • Return on capital investments of at least 25%

Management’s long-term growth targets are respectable, but this doesn't make it the next CMG, PNRA, or even NDLS.  It’s a low-margin, low-return, single daypart sub shop with declining traffic and little competitive advantage over its peers.  Current consensus estimates are for -1% adjusted EPS growth in 2014, not exactly the type of growth we’d expect to see from a "growth" chain with a premium multiple.

The stock is currently trading at a P/E of 64.36x and 23.93x EV/EBITDA on a NTM basis, multiples substantially higher than the ones awarded to Chipotle.  To put that in perspective, a chain that delivered 1.5% comp growth in 2013 is trading at a premium multiple to one that delivered 5.6% comp growth in 2013 with a 5x larger store base.  Yet, people want to talk about how expensive CMG is?

Potbelly was merely the beneficiary of a hot IPO market and if the fundamentals don’t begin to align with expectations, we continue to see downside in the name.  We think PBPB can be a feasible, financially robust company over the long haul but the current fundamentals suggest the company is grossly overvalued.  

Howard Penney

Managing Director