PBPB - Potbelly: Sales Growth Is Slowing But Margin Improvement Is Tracking Well

2023-11-26 01:09:39 ET

Summary

• Potbelly's Q3 2023 sales were similar to Q2 2023 sales after adjusting for seasonality, and Q4 2023 sales are expected to be at a similar level based on guidance.
• Thus I expect flat to low-single digits same-store sales growth in 2024, which would allow it to meet its prior target for 2024.
• Potbelly has outperformed expectations around shop-level margins, but still needs a bit more improvement to hit its 16% target for 2024.
• I am modeling Potbelly's shop-level margins at 15% for 2024, as slower sales growth will hamper its rate of margin improvement.

Potbelly Corporation's ( PBPB ) Q3 2023 earnings report confirms that its sequential sales growth is slowing. Adjusted for seasonality, Potbelly's Q3 2023 sales were similar to its Q2 2023 sales, and its guidance for Q4 2023 indicates expectations for a similar sales level there too.

I'd expect Potbelly to guide to flat to low-single digits same-store sales growth in 2024, which still isn't bad given that it should need less than +1% growth to hit its 2024 sales target (which it mentioned in early 2022 ).

Potbelly still needs a bit of improvement to hit its 16% shop-level margin target for 2024, although it is getting reasonably close and I expect its shop-level margins to be around 14% to 15% in Q4 2023.I had previously believed that there was a good chance that Potbelly's sales growth was plateauing, and thus Potbelly's sales results for Q3 2023 and its Q4 2023 guidance was in-line with my expectations. Potbelly's shop-level margins are generally exceeding my expectations though. I had believed that Potbelly would end up with shop-level margins near the high-end of its guidance range of 12% to 14% in Q4 2023, but it delivered 14.6% in shop-level margins without the benefit of sales outperformance.

The margin outperformance has contributed to my increasing Potbelly's estimated value back up to around $8 to $9 per share. This is a $0.50 per share increase in estimated value at the midpoint of that range.

Sales Growth Has Slowed

Potbelly reported +8.0% same-store sales growth in Q3 2023, in-line with its guidance for +7% to +9% same-store sales growth for the quarter. Potbelly's average weekly unit volumes went down by -3% in Q3 2023 compared to Q2 2023.

Potbelly is now guiding for +4% to +6% same-store sales growth in Q4 2023, along with $24,250 to $24,750 in average weekly sales per store, which at the midpoint would be another -3% decline compared to Q3 2023.

From looking at pre-pandemic data, it appears that Potbelly's Q2 sales tend to be a bit higher (such as 2% to 3%) higher than its Q3 sales, which in turn are slightly (such as 2% to 3%) higher than its Q4 2023 sales.

Adjusted for seasonality then, I'd consider Potbelly's sequential sales growth to be roughly flat from Q2 2023 onwards (based on its Q3 2023 actuals and Q4 2023 guidance). Overall this level of sales performance is pretty solid given the negative impact of the student debt forgiveness plan being struck down. A smaller amount of student debt relief has been going through .

Potbelly expects its AUV for the full year to be around $1.29 million in 2023, so it needs less than 1% growth in 2024 to hit its $1.3 million target for that year. I'd expect Potbelly to guide for flat to low-single digits same-store sales growth in 2024, allowing it to meet its sales target.

Notes On Shop-Level Margins And EBITDA

Potbelly reported another quarter of stronger than expected shop-level margins. It reported 14.6% shop-level margins in Q3 2023, compared to its guidance for 12% to 14% shop-level margins during the quarter. This margin outperformance came despite its sales growth falling squarely within its guidance range.

Potbelly's strong shop-level margin performance (relative to guidance) has allowed it to beat its EBITDA guidance as well.

Potbelly expects 12.5% to 14.5% shop-level margins in Q4 2023, although it has been consistently exceeding its guidance around margins. Thus 14% to 15% shop-level margins in Q4 2023 is probably a reasonable expectation, putting it towards (or above) the high-end of its guidance for the quarter.

This would put Potbelly near 14% shop-level margins for the full year of 2023. Potbelly's 2023 results were negatively affected by Q1 2023 shop-level margins at 12%, so even without further sequential improvement, Potbelly could probably get around 14.5% for shop-level margins in 2024 currently. It still needs a bit of improvement to reach its 2024 target for 16% shop-level margins though.

With sales growth slowing, I think 15% to 15.5% shop-level margins in 2024 may be a decent expectation for Potbelly, although 16% may be a stretch to get to without improved sales growth/

Franchising

Potbelly has also made decent progress in signing development deals for new franchises. It mentioned that it had 150 total shop commitments as of its Q3 2023 earnings report and subsequently announced a 22 shop deal involving 13 new units and the transfer of ownership of nine existing restaurants.

In Q3 2023, 14% of Potbelly's system-wide sales came from franchise shops, up from 10% in Q3 2022.

Estimated Valuation

I've bumped up Potbelly's estimated value back up to $8 to $9 per share. I had recently trimmed its estimated value to $8 per share based on my belief that its sequential sales growth had largely stalled out. Potbelly's Q3 2023 results and its Q4 2023 guidance adds validity to that belief.

However it is also tracking a bit better than I expected with respect to shop-level margins. Potbelly's 16% shop-level margin target for 2024 may be somewhat challenging to get to without much in the way of sales growth. I believe that Potbelly can get to around 15% to 15.5% for 2024 though.

This is a slight increase from my previous expectations and thus contributes to a modest $0.50 increase in estimated value at the midpoint of my valuation range.

Conclusion

Potbelly's period of strong sales growth appears to have come to an end with its Q3 2023 sales around the same as Q2 2023 after adjusting for seasonality. Potbelly's guidance for Q4 2023 indicates expectations for a similar level of seasonally-adjusted sales as well. Despite this, Potbelly's current sales levels are already quite close to its 2024 targets, so it should be able to reach that with relatively flat same-store sales growth compared to 2023.

Potbelly has been exceeding expectations for shop-level margins and should finish the year at close to 14%. This included weaker Q1 2023 shop-level margins, so its shop-level margins from Q2 2023 to Q1 2024 should end up around 14.5%. Potbelly may fall a bit short of its 2024 target for 16% shop-level margins without more sales growth though.

I've increased my estimate of Potbelly's value to $8 to $9 per share to reflect its stronger than expected shop-level margins and its continued flat sequential sales growth. At a bit over $9 per share, Potbelly's stock is slightly on the pricier side based on my 2024 expectations though, so it will need to deliver slightly better sales growth and/or margin performance than what I have modeled.

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