Panera Bread: Hungry for Growth

Panera Bread Co. (Nasdaq: PNRA) ($38.28) operates a chain of more than 1,100 bakery cafes in the U.S. Roughly 40% of its current locations are owned directly by the company with the remaining 60% operated under franchise agreements.

PNRA operates in about 40 states and has traditionally focused on opening locations in malls rather than as standalone locations.

Competitive Advantages

PNRA's main competitive advantage is its brand name and the loyalty of its customers. According to a series of surveys reported in The Wall Street Journal, Panera has the highest level of customer loyalty among so-called "fast-casual" restaurant chains. Fast-casual chains are restaurants that offer the speed of fast-food chains and the food quality and atmosphere of more traditional full-service restaurants.

The firm has developed a reputation for using fresh ingredients and preparing items from scratch in-house. For example, PNRA freshly bakes all of the bread used in its restaurants -- bread is delivered daily to all locations. This quality gives Panera a leg-up on most fast-food chains.

And PNRA's use of fresh and higher-quality ingredients also plays into another key trend -- Americans increasing desire to eat healthier foods. Consumers are shying away from unhealthy foods like burgers and fries and moving toward alternatives like natural and organic foods -- Panera has several menu items that are lower in fat or cholesterol or use all-natural ingredients.

Some fast-food chains have begun to adapt their menus to try and target PNRA's traditional market. For example, McDonald's has introduced a line of salads and gourmet sandwiches, as well as specialty coffees. But these chains still don't have the capability to offer the menu variety of Panera.

And the firm also offers something else that fast food chains cannot -- a better atmosphere. PNRA locations are designed to feel like cafes with comfortable furniture and restaurant-quality lighting. Often locations offer services such as wireless Internet access to encourage consumers to linger in their cafes.

Growth Drivers

Panera has two main growth drivers -- growing its base of locations and growth in sales at existing cafes. As for the first point, the company still has only 1,100 locations, all in the U.S. That's a fraction of the 13,700 locations McDonald's has in the nation. And PNRA has just begun to tap into international markets. The chain plans to open is first stores in Canada this year and has no exposure to either Europe or Asia.

All told, PNRA should be able to continue opening up 160-180 new stores per year over the next few years. Eventually, the company believes it could have as many as 4,000 U.S. locations without poaching on existing restaurants.

Growth at existing locations has become more difficult in recent quarters with PNRA reporting declining comparable store sales growth -- there's still growth, but not at quite the level of a few years ago. Comparable store sales is a key metric used in the restaurant business, measuring growth in locations open for more than one year.

Nevertheless, longer-term PNRA has an outstanding record of comparable store sales growth. And management has taken steps to re-accelerate growth including introducing popular new menu items such as new breads and sandwiches.

Valuation and Outlook

PNRA stock has been hit due to concerns over slowing consumer spending and weakening comparable store sales trends over the past year-and-a-half. But management has already taken steps to help reverse that trend.

Meanwhile, shares trade at a bargain basement valuation. The stock sells for less than 17 times 2008 earnings and sports a long-term growth rate of +18%; the firm's PEG ratio is currently less than 1.1 -- unusual for a well-established growth stock.

Expansion into new markets coupled with management's menu initiatives should help to re-accelerate growth in coming quarters, offsetting the effects of weaker consumer spending. And management has also raised prices lately, helping to offset increases in the cost of food ingredients. That should help keep margins high.

As sales growth recovers, PNRA could easily trade to a PEG of 1.5, sending to stock into the high $50s over the next two years.

Disclosure: none

Comments

[mpharbold1:]

I disagree with your assessment. You fail to mention the skyrocketing price of wheat - a major cost for PNRA. And you fail to mention slowing consumer demand for casual dining in general. Chains like McDonalds are the winners here as the consumer becomes pinched. PNRA has been dropping for good reasons (similar to SBUX). I think PNRA's growth is not only slowing, but they are actually on the verge of declining. A PEG > 1 seems way too expensive for the current environment. And their WiFi advantage - well WiFi is becoming common everywhere including McDonalds!

2008 Mar 13 03:20 PM