The Panera Bread Company Boulder Is Rolling Downhill - Is It Near The Valley?

Jul.18.14 | About: Panera Bread (PNRA)


Is the PNRA "broken growth" story similar to playing chicken with a boulder rolling downhill?

The healthy movement has been slow, but steady. PNRA is aligned with the movement while also providing convenience comparable to traditional fast food.

PNRA is constantly looking at strategies to improve growth -- Panera 2.0, catering hubs.

Where is Panera's valley?

Panera Bread Company (NASDAQ:PNRA) stock has tumbled recently -- down 34% from its 52-week high -- but is still trading at 22x trailing earnings. Before looking at their story, the recent performance and current multiple are not reassuring. Add in the current TMC/GDP at 123%, you have a sliding company trading at an above average multiple in an overvalued market.

It looks as though buying PNRA is akin to playing chicken with a boulder rolling downhill. For me to play this game, I need to have an educated approximation of where the valley lies. Valuation multiples over the past eight years can help determine the bottom.

Low 2.4 ('07) 13.0 ('07 & '09) 20.0 ('07)
Average 4.8 15.5 26.2
Est. "Valley" $59.84* $134.4 $139.88
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It is important to note that PNRA grew earnings 17% in 2007 despite the low multiples. Compare this to current multiples of 21.5x earnings, 13.5x EBIT, and 5.9x book value.

*The P/B multiple is skewed by an outflow of cash for share buybacks -- if removed, P/B is roughly 3.8 creating a "valley" of $87.00.

The Healthy Movement

Consumer's are progressively searching for healthy food alternatives. More than half of consumers agree that it is important to eat healthy. PNRA has an interesting position in this trend, being a fast-casual restaurant aimed at healthier eaters. PNRA has doubled-down on this position by stating they will remove all artificial ingredients from their food by 2016.

The three hurdles for this movement are convenience, pricing, and habits (or addiction). Here are reasons, excuses, or rationalizations (take your pick) for going to McDonald's (NYSE:MCD) over a healthier option.

  • Convenience: "I'm hungry, don't want to wait or cook or even get out of my car, so I guess McDonald's it is."
  • Pricing: "I have $4 bucks in change and want a snack so I guess McDonald's it is."
  • Habit/Addiction: "I just crave something greasy, and a Coke, so I guess McDonald's it is."

PNRA's easiest victory is convenience. There are many locations with drive-thrus, while more are being retrofitted to allow for them.

Pricing is not as easy. PNRA has increased prices 7.9% since 2011 as a tool to increase comp sales. As PNRA grows, it could use its size to command lower prices from suppliers but until that happens MCD's will dominate the low price battle.

Now for the touchy subject. Unhealthy food has some addictive qualities that simply could be cravings or something more deeply rooted in people's brain chemistry (e.g., tobacco). The healthy movement may provide some "peer pressure" for consumers to avoid traditional fast food, but it will be a slow transition with the total size of the movement unknown.

Constantly Looking for New Growth

PNRA shows no signs of complacency seen by their constant efforts to improve and find new growth. In their Q1 2014 conference call, they unveiled plans for Panera 2.0. This is a technology upgrade on customer's dining experience. It includes online ordering, in-store kiosk ordering, improved website, and a mobile app. This strategy, if successful, will improve customer's experience and margins. Read Ganggas Harjianto's article for more on Panera 2.0 and PNRA tech improvements. The company has also added catering hubs. These will be located in high sales areas.

Past Performance

Comp Sales Growth:

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Source: Panera financial reports.

Unit Growth:

  2013 2012 2011
Store Count 1777 1652 1541
Growth 7.6% 7.2%  
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PNRA plans to increase store count by roughly 125 in 2014 -- 7.0%.

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Despite declining gross margins, PNRA has been able to increase operating margins by 1.37% since 2004 with a consistent rise over time. Panera 2.0 should work in favor of operating margins into the future.

DCF Model

Given past data and future trends, I estimate PNRA to grow owner's earnings* by 12% for the next five years. This is based on comp sales growth near 5%, unit growth near 7%, and modest operating margin expansion. The unit growth does not translate into 7% revenue growth given the openings throughout the year.

With a discount rate of 8% (opportunity cost), five-year growth at 12%, and long-term growth at 3.5%, PNRA's estimated value is $167.26 giving a margin of safety of 14.5%.

*owner's earnings calculation: (EBITDA - ave. maintenance CAPEX - interest expense)*(1-tax rate)

Should a Higher Margin of Safety Be Required?

PNRA's recent downward slide, slightly slowed growth, potential lows based on P/B, and my expectation of low market returns may require a higher MOS. The long-term outlook for PNRA is more positive with it's solid balance sheet, health trends, and strong management.

My Recommendation

I would recommend sticking your toe in the way of the PNRA boulder in the form of a small long position. If PNRA continues to roll downhill, you can nurse your broken toe while adding to your position -- given no negative change to PNRA's business.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in PNRA over the next 72 hours. 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.