Description

Overview

Panera Bread operates ~1300 bakery cafes (43% company owned; 57% franchised).  At $46.25, the stock sports one of the more expensive multiples in the restaurant/consumer space at 18x consensus '09 ($2.60) and 19x my estimate. 

With the company already experiencing slowing comp trends (which should continue to worsen going forward) and potentially slower unit growth as well, the stock faces a high likelihood of multiple compression.  At 15x '09 consensus, the stock would trade at $39.  If transactions continue to worsen going forward (likely given accelerating consumer pullback), the stock could very well go lower into the low 30s. 

Slowing Trends

Company-owned comps
2008
1Q:  3.3%
2Q:  6.5%
3Q:  3.0%

Transaction growth
2008
2Q:  0.7%
3Q:  -3.5%

For 3Q, the company reported a 3% comp, which was a marked decrease from 2Q's 6.5% comp.  The 3% comp was largely driven by a 6.5% price increase, with negative transaction growth of 3.5%.  The company's main explanation for the declining transaction growth was that they ran very little media when compared to the prior year.  They expected to run more radio ads in November/December though they still guided to -4% to -2% transaction growth and 1% to 3% comps for 4Q. 

Through the first 27 days of the fourth quarter of (September 24, 2008 to October 20, 2008), trends have remained weak:  "comparable bakery-cafe sales for Company-owned bakery-cafes have grown approximately 2.1% (net of negative transaction growth of approximately 3.4%) and comparable bakery-cafe sales for franchise-operated bakery-cafes have grown approximately 3.0%."

Outlook
For 2009, the company is looking at eps between $2.55 to $2.71, which would represent an increase of 15% to 22%.  The main components behind this are:
-  Negative transaction growth of -4% to -2% and comparable company owned sales between 0% and 2%
-  80 to 90 new unit openings
-  Comfort with cost inputs (Panera has already purchased all its requirements for wheat for 2009)

While on the surface, some of the assumptions underlying guidance might seem conservative, the company will need transaction growth going forward at some point, and unless you are bullish about the economy, that does not seem likely short to medium term.

Moreover, it's very possible that transaction growth is even weaker than expected and comps turn negative.  The question then centers on the extent of de-leveraging this will have on margins outside of the food costs that have been locked in (according to the company, each point transaction has 30-40 basis point margin impact).

Summary
PNRA is an expensive stock with heavy exposure to discretionary consumer trends.  Guidance of 15-22% eps growth for 2009 seems aggressive in light of slowing comps and new unit development.  When PNRA was a growth company trading at 20x+ eps, the model roughly worked as follows: 
16-18% unit growth

2-5% comps

3-6% operating leverage

The new model for this year seems more like: 

~7% unit growth
Negative to 0% comps

As the market realizes that PNRA's old model is no longer appropriate, the stock's multiple should shrink substantially.   

Catalyst

Slowing comps/transactions and resulting de-leveraging of income statement