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Is This Baker Ready to Play?

February 23, 2014 | About:

It has come to be a fact that the restaurant industry has no self-evident recipe for success. Panera Bread Company (PNRA) is one of the big boys in the fast bakery-coffee category, owning and franchising stores under Panera Bread, Saint Luis Bread Co., and Paradise Bakery brands. Working the suburban strip malls and regional malls all across the US, Panera Bread operated 1,736 bakery-cafes by the last quarter of 2013. Panera’s main products include baked goods, custom roasted coffees, sandwiches, soups and salads, as well as fresh dough and sweet goods which it supplies through a contract manufacturing arrangement to both owned and franchised cafes.

Competition and Brands

Last year the company faced the pressures this industry is always subjected to, with increased competition and erosion of consumers’ spending. The intense industry rivalry and low barriers to entry tend to make it difficult for restaurant operators to establish an economic moat. Nevertheless, the management showed a strong commitment towards the improvement of its performance and efficiency. By refining its customer experience through peak-hour, throughput capacity and additional labor, investing in production equipment with several process and technology improvements, and developing a new menu structure with portion-size flexibility, Panera came to reach most desired results. The sales increased 1.7% the last year, and are expected to grow even more throughout 2014, capitalizing the effort on management improvement made during 2013. Yet, the bakery-coffee industry competition, plus the decline on consumers’ spending, will undoubtedly keep the numbers pretty tight.

It’s hard to say whether Panera has fully developed the brand intangible assets or cost advantages as to consider an economic moat, but indeed the success it has had in the past few years’ shows the company is moving forward in the right path. In this point the company will have to focus on the development and enhancement of the Brand’s intangible asset, and increase the operating leverage inherent in its restaurant model in order to sustain the impact on operating margins of the throughput investments. Panera is still one of the leaders in the fast-coffee industry, with sales of $4.3 billion in 2013 and strong long-term unit expansion and margin expansion potential.

Fast-casual restaurants’ boom

Fast-casual restaurants are likely to show a 10% growth during the next years due to the lower real estate and labor costs this industry has, compared to casual dining operators. Also, consumers are showing an increased demand for healthier and different food items, adding another reason why fast-casual restaurants are expected to grow.

The competition will be increase as the restaurant operators find themselves with easier access to capital in recent months. The continuous innovations Panera is making and the costumers’ loyalty are proving the company will remain competitive. Still, the competition is starting to grow. Chipotle Mexican Grill (CMG), Noodles (NDLS) and Potbelly Corp. (PBPB) are showing also signs of growth. Chipotle Mexican Grill for example, is growing with the addition of new restaurants and increasing comparable sales. Its revenue grew from $471 million in 2004 to $3,215 million. Despite the competition, several analysts have come to believe that the commercial real estate availability, plus the consumers’ acceptance of the brand, might be magical combination for Panera Bread Company Inc., to expand its stores, expecting a significant add of more than 1,200 new locations in the next 10 years.

What to expect

Panera reported a fourth-quarter profit of $54.2 million, $1.96 a share, and a revenue rise of 16%. The stock fell slightly on Tuesday, but is already up to more than $183 per share. Panera is now making some moves using its free cash to buy back stock, as well as investing in operational improvements.

Despite the improvements Panera made through the last year, and the EPS growth of 1 point from 5.89 during 2012 to 6.81 during 2013, some analysts think the current valuation is rather spicy. It seems the business model will not promise more than 8% sales growth during 2014, and the store sales remain weak and down 2.2% year over year. Panera is expected to grow, but the thing investors are looking at is the high price the company is showing, confronted to the growth expectations. Chipotle Mexican Grill trades higher, but has a five-year sales growth average of 20%.

Bulls are focusing rather than in the difficulties the company had to overcome the last quarter of 2013, on the fact that they did beat the expectations and closed the year with a strong unit growth. The question is whether the problems Panera is facing are inherent to their business model, or context-industry issues. The restructuring efforts of the management are showing a sustained growth, and might be proving to be the key to Panera’s stability. Unit growth is still poised to grow 6.5% to 7% for the full year, even in this macro-challenging environment.

The long term franchisees system, the increasing free cash-flow, and the perfection of management and expansion of product lines such as fresh dough are the reasons why this growth is estimated for 2014. Still, Panera has to create a significant difference towards its competitors, and the focus might have to be put on the development of a brand loyalty and intangible assets. It seems, however, that most investment gurus, including Ray Dalio (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio), do not feel bullish enough about this stock, as they have been decreasing their stakes in the company.

Disclosure: Damian Illia holds no position in any stocks mentioned

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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