Panera Bread - Morgan Stanley Is Right, On The Back Of A 'Full' Valuation

Oct. 1.13 | About: Panera Bread (PNRA)

Shares of Panera Bread (NASDAQ:PNRA) sold off on Monday's trading session after the company received a downgrade from Morgan Stanley, citing growth worries. Shares were trading with losses of up to 4% on the back of the research note.

After a weaker second quarter, analysts are concerned amidst pressure on discretionary spending, triggering an almost 20% sell-off over the past four months.

I agree with the analysts and remain on the sidelines on a "full" valuation amidst much slower comparable sales growth. I might reconsider my stance if shares were to sell off another 20% or so.

Morgan Stanley's Downgrade

On Monday, Morgan Stanley (NYSE:MS) downgraded Panera Bread from overweight to an equal weight, while lowering their $190 price target to $178 per share.

While the "equal weight" rating is equivalent to a hold rating, the market showed a pretty strong reaction to the downgrade by the bank.

Analyst John Glass at the bank noted, "While check growth is a complex combination of pricing, mix, and catering, it is clear from our survey work that value is a perceived weakness in an otherwise sterling brand."

According to the bank's research, a third of Panera's customers think menu prices are high which could negatively affect traffic numbers. On the back of slower check growth, the bank is cutting earnings per share estimates for the remainder of the year and into 2014.

Disappointing Second Quarter Results

Shares of Panera Bread fell from $182 to $170 per share on the 24th of July, in a response to a disappointing set of second quarter results.

The company reported an 11% jump in quarterly revenues, coming in at $589.0 million. Yet revenues fell short of consensus estimates of $596.0 million. Earnings per share rose from $1.50 last year to $1.74 per share in the second quarter, falling three cents short of consensus as well.

On the back of the results, Panera Bread guided for full-year earnings of $6.75 to $6.85 per share, falling short of consensus estimates of $6.82 per share.

At the time, the company already noted some weakness for the start of the third quarter. Same-store sales for the first month into the third quarter rose a paltry 2.1%, near the low end of its guided 2.0 to 4.0% increase in same-store sales for the third quarter.

Valuation

Panera Bread ended the second quarter with $341 million in cash and equivalents. The company operates without the assumption of debt, for a solid net cash position.

Full-year revenues could come around $2.4 billion, while full-year earnings could come in around $200 million.

Trading around $159 per share, the market values Panera at little over $4.9 billion. This values operating assets at $4.6 billion, the equivalent of 1.9 times annual revenues and roughly 23 times expected annual earnings.

Panera does not pay a dividend at the moment.

Some Historical Perspective

Shareholders in Panera have seen great returns. Shares halved from levels around $75 in 2006, falling to levels in their mid-thirties a year later.

Shares have risen to highs of $195 in May of this year, but have fallen almost 20% to levels just below the $160 mark at the moment.

Between the calendar year of 2009 and 2013, revenues were up by a cumulative 77% to $2.4 billion. Earnings are expected to rise by a cumulative 133% to $200 million in the meantime. The company has retired some 5% of its shares outstanding, boosting earnings per share growth even more.

Investment Thesis

The reaction to Morgan Stanley's downgrade has been quite severe, even as the company only downgraded the stock to the equivalent of a hold.

The lower guidance for the year, which implies 15 to 16% earnings growth, compares to a previous guided 17 to 19% growth. This lower guidance has taken a toll on the valuation multiples. Lower discretionary spending, as check growth was under pressure, as well as more competition from cheaper rivals, are all reasons for worries.

But the biggest sign of a "full" valuation might have come from the company itself. In the second quarter, when shares peaked at almost $195 per share, the company did not repurchase any of its own shares. This is despite the fact that the company has $560 million remaining under its $600 million share repurchase program, and the fact that Panera operates with a net cash position of $341 million.

As same-store sales growth has slowed down significantly, and will come in around 3% for the year, Panera relies more on store openings, expanding its total store base from a current roughly 1,700 bakery-cafe locations. Managing this operationally will result in more capital-intensive growth, while keeping up historical growth rates will become increasingly more difficult.

Valued around 23 times earnings, the valuation is full, and the recent 20% sell-off is warranted. I remain cautious and agree with Morgan Stanley that the recent sell-off does not automatically translate into a buying opportunity yet.

I remain on the sidelines, reconsidering my stance if shares were to sell off towards $120-$140 per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.