Panera Bread Rising To The Challenge

By Kristin Graham | July 26, 2009 AAA

In past years, Panera Bread (Nasdaq:PNRA) has stood out in the crowded casual dining industry by reporting soaring revenue, even in the midst of a severe recession. From 2006 through 2008, the company averaged 26.7% annual sales growth. The top-line performance captured the eyes of investors hungry for growth. In 2008, the stock rose 50.2% in comparison to the S&P 500, which crumbled nearly 38%.

But life was not all that sweet for Panera. Despite ringing up an dazzling top line, management proved inept at rising to the challenge and reporting profits to match.

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Sweet, but With a Bitter Aftertaste
After years of proving inefficient and unable to manage expenses, investors may be relieved that the company finally reported second-quarter earnings growth this week of 24.7%. Unfortunately, the income statement see-sawed and revenue inched up just 3.1%.

I've long had mixed feelings about Panera. From a consumer perspective, the restaurant offers a great atmosphere, quality coffee and tasty food for reasonable prices. These characteristics have drawn me to become a loyal customer. Yet from an analyst perspective, I've had trouble wrapping my head around why investors rewarded a company that financially, appeared to be clumsily managed. So despite this quarter's tepid sales growth, I actually like Panera more today as an investment than I have in the past.

Year YOY Revenue Growth YOY Profit Growth
2008 21.8% 17.4%
2007 28.7% (1.7%)
2006 29.5% 12.8%

In recent quarters, management showed drastic signs of improved operations. More impressively, they did it in the midst of a major economic downturn. The company was able to leverage expenses despite slowing sales growth. The company also improved its operating margin 140 basis points via several management initiatives.

Don't Click "Buy" Just Yet
As thrilled as I was to see operational improvement in Panera, I'm still not ready to whip out a bullish call on the stock. Here's why:

  1. First, the company needs to continue to shows its ability to effectively manage costs for several quarters. After years of maintaining a sloppy income statement, it will take more than a quarter or two of improvements to convince me things are in order.
  2. Second, the stock sells at 22 times its trailing earnings; that's expensive given that I expect the restaurant industry to greatly contract in the next several years. It's particularly expensive given that robust restaurant brands that operate on a large global scale like McDonald's (NYSE:MCD), YUM! Brands (NYSE:YUM) and Burger King (NYSE:BKC) are all selling for less than 17 times trailing earnings. In all honestly, I don't think any restaurant enterprise is worth more than 20 times earnings in this environment.
  3. Lastly, since 2004, Panera has nearly doubled its store count from 741 to 1,345. By operating in a narrowing industry, Panera is going to have to find a way to grow organic sales and stop relying on expansion plans. The way management handles this maturing phase will make or break the company's future.

The Bottom Line
There are few restaurant stocks I would even consider looking at as investments these days, but Panera is truly a cut above the rest. That said, I wouldn't touch the stock until I see price multiples contract. I think the company has issued some overly rosy guidance, predicting 21-32% EPS growth in the coming quarter. If investors are disappointed in a few months, perhaps a more appropriate price will quickly become available. (For more, check out Sinking Your Teeth Into Restaurant Stocks.)

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