Potbelly: Challenging environment stunts short-term growth, but long-term story intact

Potbelly Corporation (NASDAQ:PBPB) delivered decent results in Q2 2024, with adjusted EBITDA at the upper end of the guidance range, despite limited same-store sales growth. Potbelly has done well in optimizing labor costs to help increase its margins at the store level to 15.7%.

However, the challenging consumer environment has some impact on Potbelly’s near-term outlook. It made a second downward revision to full-year 2024 guidance and now expects same-store sales growth to be roughly the same and adjusted EBITDA growth to be flat compared to 2023.

This represents about a 4% to 5% reduction in same-store sales growth and a 10% reduction in adjusted EBITDA growth compared to Potbelly’s original 2024 guidance.

Potbelly’s strategy and operational management look solid and I think it can return to growth in the coming years. However, the outlook for stable (or potentially slightly negative) growth in the near term resulted my estimate of its value being reduced to $8.50 to $9.50 per share.

Q2 2024 results

Potbelly reported same-store sales growth of +0.4% in Q2 2024, which was in line with its expectations for flat-to-same-store growth of +2% for the quarter. It continued to grow its market share in an overall challenging environment.

Potbelly did well in terms of adjusted EBITDA, reporting $8.5 million in the quarter. That was on top of its expectations of $7.0 million to $8.5 million in adjusted EBITDA for Q2 2024.

Although Potbelly’s same-store sales growth was limited during the quarter, it achieved improvement in its store-level margins, which contributed to its strong adjusted EBITDA results.

Potbelly’s store-level margins reached 15.7% in Q2 2024, which was a noticeable improvement compared to its 14.4% store-level margins in Q2 2023 and 13.5% margins at the store level in Q1 2024.

Potbelly benefited from workforce optimization efforts as labor and related expenses decreased from 30.4% of revenue in Q2 2023 to 28.0% of revenue in Q2 2024.

In absolute dollar terms, Potbelly’s labor and related expenses were down 15% year-over-year, while, by comparison, the number of company-operated stores was down 7% year-over-year. Thus, its labor costs appear to be reduced by a fair amount more than can be accounted for by the conversion of company-operated stores to franchised stores.

Potbelly has increased its franchise commitments by a further 22 in Q2 2024, so it is making solid progress on this front.

Updated guide

While Potbelly’s performance in Q2 2024 was solid, it cut its guidance for the full year due to the “challenging macro environment”. Potbelly had previously expected low-single-digit same-store sales growth, which was already a cut from its initial guidance for same-single-digit same-store sales growth. Potbelly now expects essentially flat same-store sales growth of -1.5% to +0.5% for the full year.

Potbelly also lowered its full-year adjusted EBITDA guidance to a new range of $27 million to $30 million. This is roughly flat compared to 2023 adjusted EBITDA of $28.3 million.

Potbelly’s prior guidance was for approximately $30 million to $31 million in adjusted EBITDA, while its original guidance was approximately $31 million to $32 million in adjusted EBITDA (growth single digit to double digit growth from 2023).

Potbelly also expects slightly negative same-store sales growth in Q3 2024 now, from -1.5% to -3.5%, although its adjusted EBITDA expectations (from 6.5 million to $8.0 million) are quite similar to the $7.3 million reported in Q3 2023. .

Potbelly indicated that it is still doing better in terms of traffic than the overall fast-casual market, but that traffic may be down a few percent year-over-year in Q3 2024. Some competitors, such as Chipotle, are still reporting growth positive traffic, so Potbelly still has room for improvement there.

Estimated value

We previously estimated Potbelly’s value at $9.50 to $10.50 per share, but noted the risk that the overall environment could lead to slightly negative same-store sales growth.

That appears to be the case, with its Q3 2024 guidance suggesting slightly negative same-store sales growth. There’s a decent chance Potbelly’s full-year same-store sales growth will also turn marginally negative.

Flat to slightly negative near-term growth expectations lower my estimate of Potbelly’s value by $1 to a new range of $8.50 to $9.50 per share.

I think Potbelly’s long-term growth story remains intact, but the $8.50 to $9.50 per share estimate still represents a healthy 9x to 10x multiple to Potbelly’s estimated adjusted EBITDA in 2024 .

Conclusion

Potbelly reported relatively flat (+0.4%) same-store sales growth in Q2 2024, while adjusted EBITDA topped guidance at $8.5 million. Potbelly did well in optimizing labor hours, contributing to that adjusted EBITDA performance.

However, Potbelly continues to face challenging market conditions and expects same-store sales growth to turn slightly negative in Q3 2024. For the full year, its 2024 results are expected to be similar to 2023 now, in down from initial expectations for a low level. Same-store sales growth in the mid- to mid-single digits and adjusted EBITDA growth in the single- to high-double digits.

Potbelly’s performance relative to the overall fast casual market remains solid and I believe it can return to growth over the long term. However, flat to slightly negative near-term growth prospects reduce my value estimate to $8.50 to $9.50 per share.