A little over a year ago, I published a piece on Panera (NASDAQ:PNRA) that gave my outlook on valuation in light of some substantial variables in the company's business model. At the time, shares were trading slightly above where they trade today, and given Panera's outlook and growth potential, I posited there were some changes the company could make to its business model that would double the value of the company over time. However, without those changes, I still thought the shares were undervalued then, and given that more than a full year has transpired, I believe shares are even more attractive at present. In this article, we'll discuss why I think so and the idea that Panera, at its current low valuation, could be a takeover target.
Before I begin, I'd like to pull a few charts from my previous article, in order to illustrate some reasons for my bullishness. Keep in mind the data doesn't include last year, but I'm simply trying to show some high level trends. First up is revenue per restaurant:
That is ridiculous growth, and what it shows is that, even as good as Panera has been, it still hasn't figured out how to maximize revenue. This is tremendously bullish, as many chains mask terrible store-level performance by simply opening more locations; Panera has store growth and terrific comp growth over time. This isn't some flash-in-the-pan fad that pops 10% for one year; this is sustainable and steady growth that has and will continue to make shareholders money.
Speaking of comp sales, this chart from my original article shows very strong performance, with a few hiccups:
Again, the point is that Panera knows how to make each location more profitable over time, and not just to goose near-term numbers for Wall Street.
Finally, Panera has turned this rapid growth not only into more revenue, but more importantly, profit:
If you'd like to see more justification, my original article outlines my full view on the business. However, these three charts show a quick glimpse of why I love Panera as an investment. Look at the profit growth at the unit level; any company would kill for that kind of margin growth.
Now, as I mentioned, shares are below where they traded when I made my original bullish call. There are many reasons for this, and chief among them, in my view, is the industry's struggle with margins amid rising commodity costs. This is something that Panera really can't do anything about, since it is forced to buy certain ingredients, and in large quantities at that. However, what it can do is swap out items on its menu that are most affected by the increases in commodity prices, make portions smaller or raise prices. Panera isn't in the situation that less profitable restaurant chains are in, where some of Panera's competitors have to do something to protect razor-thin margins (or negative margins). Panera has terrific margins for a restaurant chain, and that is a result of strong traffic and pricing power. Of course, Panera is at the mercy of commodity prices, but to throw it into the restaurant basket with also-rans is irresponsible and short-sighted. Do you put McDonald's (NYSE:MCD) and Jack In The Box (NASDAQ:JACK) in the same boat? Of course not. You don't lump superior operators in with inferior ones, and I think that's what has happened to Panera shares over the past year or so.
Panera has had its issues, including a rough first quarter that saw disappointing revenue, margins and guidance. This quarter was terrible, so I won't sugarcoat it. However, I don't think it was as bad as it seemed. The rough winter affected thousands of businesses, and Panera was not exempt from the thrashing. Margins were also depressed on investments in new technology and low traffic, but I think all of these issues are transitory. The winter is over, investments are, by definition, temporary, and the commodity spike appears to be a smaller issue than it was. In short, yes, the quarter was terrible and shares were punished, but I think it was an overreaction.
Amid all the negativity, there is a lot to like when looking at Panera shares. Most recently, the company announced an enormous buyback that could see nearly one in seven shares retired at current prices. That is one of the biggest buybacks I've ever seen, and anyone that reads my articles knows I love buybacks as a way to return capital to shareholders.
There is also the bevy of reasons I mentioned in my original article and referred to above. This is a great business that has found a niche and exploded in popularity. Panera is also far from saturation, and it means that the company and franchisees can continue to open new stores for a long time to come. Couple that with the ridiculous growth in unit-level economics, and the picture for Panera as a whole is very bright.
Now that shares have been beaten down, they are also very cheap. This chart from YCharts shows what I mean:
As you can see, PNRA's trailing PE is near its five-year low, indicating that the market's optimism regarding PNRA's future is low. This provides a margin of safety for new investors looking to get in. I would like PNRA even if its PE was at a more normalized level, but at 22 times trailing earnings, I think it's an amazing opportunity. Even without a potential buyout, PNRA shares are near their bottom, in my view.
However, I mentioned in the open that I think PNRA is a great buyout candidate. Not only is all of the preceding information present, but PNRA is ripe for being taken out. The company has a great business that can't be easily replicated, it is very profitable and has been for a very long time, it's got a great brand that everyone knows, it is cash flow-positive, and on top of that, it has no debt. This means that an LBO firm could borrow at rock-bottom rates and lever up the private version of PNRA, taking the ~$150 million in annual free cash flow Panera reliably generates.
Regardless, even if it weren't an LBO firm, a strategic buyer could be interested in Panera. Even a buyer like McDonald's could make Panera a bite-sized acquisition. I'm not suggesting MCD is going to buy Panera, but a company like McDonald's certainly could. Panera's current market cap of about $4 billion means it's a pretty small acquisition for many larger companies. I think a strategic buyer is less likely, but an LBO purchase would be pretty easy.
I think PNRA has nice upside over the medium term, given its status as an independent company. Earnings will recover, and the multiple will as well. PNRA could easily earn $8 next year, and if we assume a multiple of 25, well within historical norms and even towards the low end, we're talking about a $200 stock price. There is upside to that, given that $8 is pretty conservative and so is a 25 multiple, but over the long term, PNRA is worthy of much, much more.
Over the shorter term, an LBO price would likely yield a much faster route to $225 to $250, as I don't think a price lower than $225 would get approved. Even at that price, I think an LBO buyer would be getting a pretty good deal, and could, instead of buying back $600 million in stock, use that cash to open new restaurants and flip the chain in a few years. Why this hasn't been tried yet is beyond me, but I certainly wouldn't be surprised if it did. Panera has a long way to go in terms of growth, and the transitory issues that have damaged shareholder value in the past year are passing, and as such, I think PNRA has big upside, with or without a buyout.
Disclosure: The author is long PNRA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.