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Potbelly's dreadful public slump continues after earnings

The Exchange

The short and so far disastrous public run for Potbelly (PBPB) was continuing Wednesday, as shares of the sandwich seller slumped following its second earnings report since its market debut last fall.

In recent trading, Potbelly was dropping more than 10% to to $20.10, mere pennies above the lowest level it hit on the session. That meant it was achieving two inglorious milestones simultaneously having the biggest single-day decline in its history and sliding to the worst price it's seen post-initial public offering.

As for Potbelly's numbers specifically, on an adjusted basis it earned 6 cents a share in the fourth quarter, 2 cents ahead of estimates carried on FactSet. Sales were another story. For the quarter, the top line ticked up 1.7% to $74.8 million 9.9% excluding an extra 14th week in the prior year quarter but fell short of expectations by about $1.2 million. Same-store sales at company-owned shops edged ahead 0.7%, if the extra week in 2012 is taken out. In all of last year, 42 new stores opened, including 34 of the company-operated variety. Total revenue rose 9% to $299.7 million, and comp sales were up 1.5%.

Potbelly's report wasn't exactly a tale of woe. It just wasn't a tale of feats of greatness, either, and therein lies the trouble. Potbelly attributed the tepid showing in part to bad weather, saying there was "no question the external environment was disruptive." This is a well-worn excuse that's been used numerous times by retailers during this particularly snowy season. But Potbelly has bigger issues than wintry weather.

Wall Street appears to be of the mind that competition is making it hard for Chicago-based Potbelly to stand out. Setting aside the fact that there are a host of restaurants in any American town, the company has to try and differentiate itself in a segment that has competitors including Subway, Jimmy John's, Firehouse Subs, Jersey Mike's, Quiznos, Schlotzsky's, Panera (PNRA), McAlister's Deli and Jason's Deli. Outside of chains, there are local delicatessens. You could even simply make a sandwich at home.

Clearly, there's no shortage of options, so a customer looking to pay in the neighborhood of $10 and up for a sandwich, soup and soda at lunchtime won't necessarily choose the Potbelly brand unless that's their personal preference. You can pick your toppings, which plays into the "customized" food mania sweeping the food arena, though that's hardly innovative considering any number of sandwich makers do the same.

The drop in Potbelly suggests the restaurant industry may not have another year in which simply being a member of the group translates to big gains. In 2013, a set of 38 restaurants rose almost 55% and nearly doubled the S&P 500's return, extending a strong, positive stretch that dates back to 2009, the start of the bull market. Since the new year began, however, a good number of those high fliers have surrendered a bit of that ground.

Of its more than 300 stores, Potbelly owns the vast majority, franchising fewer than 10%. Investors have been favoring franchisors such as Burger King (BKW) and Wendy's (WEN), although that certainly hasn't hurt Chipotle (CMG), which owns all of its locations. The lesson here is a stock can win with the ownership model, but it has to dominate a niche, as well as the perception it's not like any other.

Potbelly's not making a convincing case. Its October IPO priced at $14, and shares surged above $30 on their first trading day. Of course, most individual investors don't have the connections to get pre-IPO pricing they get the retail market price. And anyone who has been around for any time in this name has probably last money. Since its $33.90 apex in the days following the offering, Potbelly has shed 40% of its value. It's recorded more down days than up, and a sizable short position has developed, now sitting at nearly 22% of the float.

The company is banking on 10% store growth and 20% or above earnings growth each year. In 2014, it believes adjusted profits will rise 25% to 35%, comp sales will increase in the low-single digits and 40 to 48 new stores will be built. The question is whether it can take market share and expand in a way that makes it the top choice in its subset, while outgrowing similar operators, keeping costs contained and staying profitable.

As a diner, you can like Potbelly and what it does. As an investor, you have to give it considerably more thought.