Digital Focus And New Franchises Will Attract Customers, But Margins May Decline

Key Takeaways

• Menu innovation and enhanced digital capabilities aim to boost sales growth and revenue.
  
• Franchising and cost control measures target unit expansion and improved net margins for higher earnings.
  
• Vulnerability to climatic conditions, franchise strategy risks, and declining transactions pressure revenue, while cost inflation threatens margins despite effective management strategies.

Catalysts

Owns, operates, and franchises Potbelly sandwich shops in the United States.

• Potbelly plans to drive comp sales growth through menu innovation and enhancements to digital and data analytics capabilities, which should positively impact revenue.
  
• The company is focusing on accelerated unit openings and market densification efforts through franchisee expansion and planned company store openings, expected to enhance overall revenue growth.
  
• Strategic cost control measures, including corporate expense management and reduced refranchising, aim to improve net margins and contribute to earnings growth.
  
• Investments in the Potbelly Perks loyalty program and consumer-facing digital assets are designed to drive higher customer engagement and frequency, bolstering revenue through increased transactions.
  
• The introduction of incentive programs for franchisees to expedite store openings is likely to expand the franchise base, supporting unit growth and long-term earnings potential.

Potbelly Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Potbelly's revenue will grow by 4.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 8.7% today to 0.5% in 3 years time.
• Analysts expect earnings to reach $2.6 million (and earnings per share of $0.06) by about March 2028, down from $40.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 240.2x on those 2028 earnings, up from 7.2x today. This future PE is greater than the current PE for the US Hospitality industry at 23.7x.
• Analysts expect the number of shares outstanding to grow by 0.13% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.03%, as per the Simply Wall St company report.

Potbelly Future Earnings Per Share Growth

Risks

• Unusual weather impacts, particularly in key regions like the Midwest and Texas, have already adversely affected same-store sales in early 2025, indicating potential vulnerabilities to revenue fluctuations based on climatic conditions.
  
• The decrease in system-wide sales and total revenue in the fourth quarter of 2024, primarily due to last year's refranchising activities, highlights the risk that the refranchising strategy may negatively impact short-term revenue figures, potentially affecting overall net margins.
  
• The company reported a decrease in transactions despite an increase in average check, suggesting that customer frequency may be a concern, potentially putting pressure on revenue if not mitigated by continued menu or digital innovations.
  
• Although unit growth is expected, the reliance on franchise development means the company is somewhat dependent on franchisees' ability and willingness to open new shops, which could delay expected revenue and earnings growth if not executed as planned.
  
• While the cost management strategy appears effective, any failure to maintain these controls amidst inflationary pressures, including fluctuations in food and labor costs, could compress net margins, affecting overall profitability.

Valuation

• The analysts have a consensus price target of $16.667 for Potbelly based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $20.0, and the most bearish reporting a price target of just $14.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $528.8 million, earnings will come to $2.6 million, and it would be trading on a PE ratio of 240.2x, assuming you use a discount rate of 9.0%.
  
• Given the current share price of $9.7, the analyst price target of $16.67 is 41.8% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.