Takeaway: While we believe PBPB will be the beneficiary of a recently hot IPO market, we suspect the stock will be on a short leash.
Potbelly is on deck for an IPO tomorrow. The company plans to sell 7.5 million shares and recently raised the expected price of its IPO to $12 to $13 per share.
In this note, we offer up our take on the latest IPO in the restaurant space. It is important to note, however, that we did not have the opportunity to meet with management nor did we attend any of the company’s road show presentations.
With that said, we believe Potbelly will be the beneficiary of a recently hot market for growth related restaurant stocks. The offering size is rather small at slightly over $95 million and demand should be high. A number of veteran restaurant analysts will be comfortable with the CEO, Alwin Lewis, who is a familiar name in the industry. Lewis spent 13 years at YUM, including a stint as COO, before leaving in 2004 to become the CEO of Sears.
Potbelly should do fine initially, but it could be on a short leash. It is a premium player in a very crowded, highly competitive sandwich (sub) market. Regarding the latter point, all of the company’s direct competitors, including, but not limited to, Subway, Jimmy John’s, Firehouse Subs and Jersey Mike’s, are private companies, which makes direct comparisons difficult to come by.
Its important to note that IPOs, particularly those from companies with strong growth stories, have fared extremely well lately. NDLS, for example, gained +104% on its first day of trading. But, investors expecting another Noodles-like performance should heed caution, as we believe this was more of an aberration than the norm. In fact, despite their similarities as fast casual operators, the two have stark contrasts. Potbelly competes in a crowded segment of the industry as opposed to Noodles, which brought more of an innovative, fresh concept to the table. In addition to competing in a less-crowded Asian segment, we would argue that NDLS is also perceived to be healthier than PBPB.
All told, Potbelly does have compelling unit economics and plenty of room to grow. The company currently has a domestic base of 286 locations in 18 states and the District of Columbia. However, the units are incredibly concentrated, as over 50% of its units are located in Illinois, Texas and the District of Columbia. Furthermore, the company has little presence outside the Midwest and Northeast. Recent expansion efforts have been strong, as management opened 21 and 31 company-operated shops in 2011 and 2012, respectively, and plan to open an additional 32-35 company-operated shops in 2013. At this time, the company does very little franchising.
The unit growth story will have to save the day, as the trajectory of same-store sales is below average for a chain this size. The company’s same-store sales grew +1.5% in 1H13, but traffic declined by -1.1%. It appears the segment is having a difficult time amid increased competition from peers and convenience stores. Subway recently saw sales decline -2% this past summer – its first decline in recent memory.
Portelly construction costs range from $450,000 to $770,000 per store and new stores are averaging about $1.1 million in sales per year, which is quite strong for a "sub" chain. Management currently targets shop sizes between 1,800 and 2,200 square feet and dining areas that typically seat between 50 to 60 people.
As it stands, we have several positive and negative takeaways from our analysis.
- Fits the current “growth” style investing theme
- Compelling unit economics
- Strong brand presence in its communities
- It will be difficult to expand the day-part mix
- Traffic trends have been weak lately
- Two states and the District of Columbia account for 53% of company-owned units
Below, we examine how PBPB’s margins stack up against some of its publicly traded peers.
Average Unit Volumes
Average unit volumes are below the publicly traded peer group, but are strong relative to other sub chains. While there is certainly room for improvement, day-part expansion will be difficult to achieve.
Cost of Sales
Food costs are in line with the peer group. Higher food costs suggest that the company is focused on selling a better product than the average QSR chain. If food costs begin to head lower over time, this could be a bad sign. In our view, a decrease in food costs would be a leading indicator of negative traffic.
We’re not close enough to the company to know what they can do to bring labor costs down from here. As for the company’s peers, we believe PNRA’s labor costs are headed higher and view CMG as the model of efficiency in the restaurant industry. PBPB’s labor costs falling between the two suggests that they are not excessive and there still may be room to the downside.
Restaurant Level Margins
Potbelly’s restaurant level margins are very strong. That said, it is hard to tell if there is significant room for improvement without leverage from higher AUVs.
PBPB is currently investing for future growth and, we believe, this is where the majority of the leverage is in Potbelly’s business model. The company must successfully execute on its unit opening strategy in order to eventually leverage its G&A costs.
EBITDA & Operating Margins
We believe there is significant room for improvement in operating margins. Given current restaurant level margins, most improvement in EBITDA & operating margins is likely to come from management leveraging its G&A.
Takeaway: The bond market doesn't believe a single word from Treasury.
By Keith McCullough
President Obama and Treasury Secretary Jack Lew are completely misrepresenting the default risk for political gain. It's shameful.
In case you somehow missed it, the Treasury Department grabbed headlines today warning the U.S. economy could fall into its deepest crisis since the Great Depression if Congress doesn't raise the debt ceiling.
"A default would be unprecedented and has the potential to be catastrophic," Treasury said. "The negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."
Really? Lew should be ashamed for spewing this fear-mongering nonsense.
As for the Bond Market...It doesn't believe a single word from these guys on default risk. Otherwise yields would be ripping.
Check out the chart below.
Keith McCullough is the Founder & CEO of Hedgeye Risk Management.
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Summary: The Labor market strength remains ongoing as claims make another YTD and multi-year low. ISM Services declined sequentially with all components losing MoM. Seasonality has shifted to a data tailwind while policy (manifest in Down Dollar & Down Rates) has shifted from benign to discrete growth headwind.
One down datapoint (ISM Non-mfg) does not a trend make, but all trends start as trades - and the probability for a negative macro Trade to evolve into a Trend breakdown in growth heightens considerably when the principal, causal factor in our model (policy) inflects negatively.
Keep the $USD front in center here as it moves towards testing its TAIL line of support at $79.21
INITIAL CLAIMS: STILL IMPRESSIVE
The ongoing strength in the domestic labor market remains impressive. Inclusive of this morning’s release, the 4-week rolling average of non-seasonally adjusted Initial claims, our favored read on underlying labor trends, registered its strongest rate of improvement since July of 2010. To quickly review the data:
NSA Claims: Non-seasonally adjusted claims printed 252K, down 3K WoW while coming in < 300K for the 10th consecutive week. The 4-week rolling average was -18.3% lower YoY, which is a sequential improvement versus the previous week's YoY change of -17.5%
SA Claims: Headline, seasonally-adjusted initial jobless claims fell -1K to 308K vs the prior week (revised) 307K. The 4-week rolling average fell -4K WoW to 304.75K – the lowest level since May of 2007.
As a reminder, in additional to the prevailing organic strength in the claims data, the series will see a building seasonal tailwind over the September to February time period. Separately, it’s worth noting that federal workers are eligible to collect unemployment while furloughed, so that may introduce an upward (albeit transient) bias in next week’s claims data and any subsequent releases so long as the shutdown remain in effect.
ISM: Sequential Softening
The ISM Non-Manufacturing Composite Index declined -4.2 to 54.4 in September with all principal components declining sequentially. Business Activity (-7.1) and Employment (-4.3) led component declines and while Export Orders (+7.0) and Prices (+3.8) were the lone gainers.
The Trend (trailing 3M/6M/12M) across the balance of sub-components remains positive at present and, notably, New Orders was down just -0.90 to 59.6 – only a modest decline in the context of last month’s ( and the cumulative 2-month) material advance and still a solid absolute reading.
On the consumer side, the recent multi-month trend has been one of improving consumption of Goods while spending growth on Services has been flat to decelerating on both a YoY and 2Y average growth basis (2nd Table below). Coupled with the fiscal policy constraints to an acceleration in disposable income growth over the near-term, today’s ISM data presages another middling growth number for Consumer Spending on Services with the September release.
One marginal negative datapoint does not a trend make, but all trends start as trades - and the probability for a negative macro Trade to evolve into a Trend breakdown in growth heightens considerably when the principal, causal factor in our model (policy) inflects negatively.
Keep the $USD front in center here as it test its TAIL line of support at $79.21.
Christian B. Drake
Takeaway: Another week, another solid jobless claims print.
Prior to revision, initial jobless claims fell 2,000 to 308,000 from 305,000 week-over-week (WoW), as the prior week's number was revised up by 2,000 to 307,000.
The headline (unrevised) number shows claims were lower by 1,000 WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4,000 WoW to 304,750.
The 4-week rolling average of non-seasonally adjusted (NSA) claims (which we consider a more accurate representation of the underlying labor market trend) was -18.3% lower year-over-year, which is a sequential improvement versus the previous week's YoY change of -17.5%. In fact, it is the fastest rate of improvement seen year-to-date and is actually the fastest rate of improvement seen since the first half of 2010.
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Final readings of Manufacturing and Services PMIs for September show the Eurozone economy grinding higher. Yesterday, Draghi reminded participants on the ECB’s conference call that the economic recovery in the Eurozone is “weak, fragile, and uneven”, but improving off low levels. We largely agree with that sentiment and given this unevenness we will note our bullish bias on German and UK equities. Looking out over the next three months we wouldn’t expect to see great gains in aggregate Eurozone PMI readings, rather slight ups and downs month-over-month on a slightly positive slope.
Our call remains anchored on changes in the slope of the data we track. Especially given what’s becoming a royal political mess in Washington, D.C., we think that actions of Obama and Bernanke to burn the USD and talk down growth will translate to EUR strength. As the chart below suggests, what’s good for the EUR/USD is also good for the DAX.
Surprisingly, Berlusconi decided to support PM Letta’s coalition government in a confidence vote yesterday, despite strong threats leading into the vote that his party would pull its support and split the fragile coalition. It’s now unclear how/if Berlusconi will have any influence on his PdL party while servicing a one-year sentence for tax fraud.
What’s clear is that while this decision will give the market a breather, we think there’s plenty of room for Italy to underperform on its fiscal consolidation targets and growth outlook over the next three months. The country’s budgetary issues should press into year-end – its decision to postpone/scrap a plan to increase the VAT and property taxes equates to ~ €3B in savings that the government must come up with in order to hit its deficit reduction target of 3% for this year. Further, Letta, needs to gain approval for the 2014 budget, which may prove challenging given continued pushback on austerity. On growth, the government last week revised down its 2013 GDP estimate to 1.3% from 1.7%. Given the coalition’s conflicts on budget reform and inability to issue the “tough” structural reforms, we think there’s more downside risk to the economy over at least the next three months.
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