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Expanding Potbelly Looks for a Pop With IPO

The Exchange

With premium pricing, fresh ingredients and ample room for expansion, sub sandwich seller Potbelly Corp. could be in the stock market sweet spot before long.

Potbelly restaurant

Potbelly, which is about to go public, said Monday it expects to see its shares priced at $9 to $11 when it finalizes its initial offering, raising as much as $82.5 million in the process. Potbelly is selling just under 7.4 million shares and shareholders are parting with another 137,834, according to a regulatory filing.

Though any stock carries considerable risk, Potbelly has a good bit in its favor, namely the fact that anyone who's visited a store likely will note it isn't struggling for business. The company, which started in 1977 and didn't open its second shop until 20 years later, is now up to 295 locations in 18 states and Washington, D.C. Another 12 units are franchised in the Middle East. Of its existing U.S. shops, Potbelly owns 288, or almost 98% of the total, with Illinois and Texas by far its biggest states.

The 'fast casual' space

Once in the public market, Potbelly (ticker symbol PBPB) will be discussed with other "fast casual" names such as Chipotle (CMG) and Panera Bread (PNRA), the growing segment that's made inroads as traditional fast-food restaurants have encountered more-discriminating diners, critical press and even shamings from politicians. As is the case with those higher-end stores, they're not giving it away at Potbelly — a regular sandwich, small soup and 20-oz. bottled drink can easily cost you near $10 before tax, with some regional variability. That said, on taste and quality, it does earn high marks. In the latest fiscal year, the company says its average bill recorded in the system was about $7.

Revenue at the chain, which counts Subway and Firehouse Subs among its direct competitors, was $220.6 million for the 2010 fiscal year, and that rose to $274.9 million last year. The store-level profit margin goal at Potbelly currently exceeds 20%, which it says it has achieved in the past three years. In comparison, margins at sandwich-and-pastry seller Panera would have been right around that same level last year, based on store revenue of $1.88 billion and costs of $1.5 billion. Potbelly is planning to open 32 to 35 corporate-owned stores in 2013, and it has a long-term aim to expand its count a minimum 10% a year.

It's not guaranteed, of course, but it won't be a surprise if the market welcomes the new name, where fast-casual stocks have been strong in the broader restaurant group. (And IPOs often get a bounce as it is, with an average 13.2% first-day return year to date, according to Renaissance Capital). This year the fast casual set of Panera, Chipotle, Einstein Noah (BAGL) and Starbucks (SBUX) is up an average of 32.2%, although tiny sandwich shop Cosi (COSI) has lagged badly, slumping more than 20%.

Fast-food stocks have also climbed, but they're skewed upward by a 76% advance in Wendy's (WEN). The quartet of that chain, along with McDonald's (MCD), Burger King (BKW) and Yum Brands (YUM), has averaged a 28.7% increase. Among sit-down restaurants, Olive Garden and Red Lobster owner Darden Restaurants (DRI) is up 2.6%, whereas Applebee's and IHOP parent DineEquity (DIN) has tacked on 2.5%. Chili's operator Brinker International (EAT) has gained 30.9%.

Pricey Noodles

A good proxy for Potbelly might be Noodles & Co. (NDLS), a similarly sized restaurant company that went public in June and more than doubled from its IPO price on its first day of trading. As of July 2, Noodles had 345 restaurants in its system, most of those company-owned, and revenue of $300.4 million in its latest full fiscal year.

Expense levels weren't that different either, with Noodles posting a 12% adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margin, vs. 11.4% for Potbelly. Each are on the low side compared with their peers, for whom this measure tends to range from a little over 11% to about 20%, but that's not hurt Noodles so far. Since its closing debut at $36.75, the shares have climbed another 18%.

Noodles now sports a forward price-to-earnings ratio of 85, well above the 17 (Einstein) to 33 (Chipotle) readings that are more common for the fast-casual arena. Tex-Mex seller Chuy's (CHUY), itself public only about 14 months, also carries a premium P/E, coming in at 45 after having risen 141% from its IPO. Here's one of the ways of looking at Potbelly: Should it price at the high end, it would have around a 17x implied multiple, based on what it says amounted to earnings of 66 cents a share last year.

Knowing how the rest of the group lines up, it's unlikely Potbelly's going to stay down there long at all.