You would, looking at the picture of me that accompanies these articles, think that a sandwich shop with the name “Potbelly” (PBPB) would appeal to me in a fundamental way, regardless of price or profitability. You would, however, be wrong. I have a deep seated dislike of the sandwich business. This has nothing to do with technical or financial reasons such as the industry’s profitability or potential, nor is it due to a dislike of sandwiches. It is for the all too human reasons…jealousy and regret.
You see, booming, successful sandwich businesses remind me of a missed opportunity. I have very few regrets in life, but sandwiches are central to one of my deepest. My wife and I met in Japan. After we married, we moved to England and managed to get transfers with our existing employers. We were young, enthusiastic and sitting on some capital from our expat days. We had an idea…we would start an American style sandwich business in the UK!
We looked at purchasing a Subway franchise. At the time, the brand didn’t exist in the UK and we were told by the company that they would not sell an individual franchise, but would consider offering the franchising rights for the country as a whole. We spoke to many people and passed on the opportunity…everybody told us that Britain, where a sandwich at that time usually consisted of one slice of ham between two slices of white bread, would not pay the price that you would need to charge for an American style sub. The rest, as they say, is history. The UK is now Subway’s third largest market with around 1600 stores.
That decision undoubtedly cost me dearly, but taught me a couple of valuable lessons. Always question conventional wisdom and never underestimate the value of a sandwich.
There would seem to be no doubt that Chicago-based Potbelly has a lot going for it. I live in a rural area and travel little, so I have never sampled their wares, but, based on anecdotal evidence from friends who have, the consensus is that the food is good, the atmosphere of the stores is welcoming and the staff is generally great. They also have one other significant advantage.
CEO Aylwin Lewis came to the company from Sears Holdings (SHLD) but built his reputation at YUM! Brands (YUM), a company that knows a thing or two about casual dining. His time at these two companies suggests that Mr. Lewis understands that, as Ray Kroc famously implied, once a food business expands beyond a certain point it becomes a real estate business.
It is little surprise then, that PBPB’s IPO was a huge hit. Shares were expected to be offered in the $12-13 range, eventually priced at $14 and hit a high of $33.78 on the first day. It is interesting to me that, at a time when most of the “big news” IPOs are tech related, the most successful is for a company that operates in an established business, has experienced management and is already profitable. Could it be that traders and investors appreciate traditional metrics after all?
Anyway, public therapy session and idle musings aside, should you buy PBPB at these levels?
Despite all of the positives, I would say no. The problem lies in the areas of valuation and expectation. PBPB has seen significant revenue growth and expanded rapidly in the last few years, but expectations for future growth are more than priced in at these levels. There are not yet enough analysts’ forecasts to calculate a forward P/E, but, based on historical earnings, PBPB is trading at over a 150 multiple. In the circumstances, that’s not impossible to justify, but may be a little rich.
If you missed out on the $14 initial offering price, then look at the performance since launch of the last popular food IPO, Noodles and Company (NLDS).
NDLS was expected to be in the $15-17 range, priced at $18, and, hit a high of $47.60 on the first day’s trading. Looks familiar, doesn’t it? The stock has not been bad since then, but neither has it been particularly good.
The same will probably be true of PBPB in the next few months. The issue is that exaggerated expectations can lead to exaggerated disappointment if they go unmet. When all of the potential good news is priced into a stock, I would rather leave it alone. If the expected results come, the price will hold, maybe even appreciate a little, but any hint of weakness could result in a significant drop. In this case, many will not want to see a profit disappear, and selling could easily accelerate.
That risk, combined with a limited reward in the medium term, suggests that if you don’t already own PBPB, you have probably missed the boat. If the inflated expectations aren’t met and the stock drops quickly, it could well represent a decent long term opportunity, but for now I will be content to watch and wait.
Of course, you may well dismiss this as the ravings of a bitter old man. You could be right; missed opportunity hurts. I didn’t buy Potbelly shares at $14 so, when it comes to sandwiches, I feel that I am doomed to make bad decisions. I have no intention of adding to that feeling by buying PBPB here but, of course, years from now, that could turn out to be just another sandwich-based regret.