Panera Bread is a great growth concept in the restaurant sector trading close to historical low multiples (24 forward P/Ex vs. a low of 22x and average of 30x, 10x EV/EBITDA and 2.8% FCF yield), $2 in net cash on its balance sheet, low sentiment and reason to expect a rebound in 2007.

 

Panera Bread is right in the sweet spot of current restaurant demographic trends and they currently don’t have any major direct competitors as their primary competition has failed to get the formula right. In addition, the financial performance of the concept is incredible

Based on units opened for at least 2 full years (221), the financial performance is below:

 

 

Very few concepts offer returns anywhere close to these levels.

 

 

PNRA has LT EPS growth goal of 25%/year.

The components of this are:

16-18% Unit growth

2-5% SSS growth

3-6% Operating leverage

 

With about 1,000 units today, PNRA should easily be about to attain 2,000 before they are fully cannibalized using conservative penetration levels. If we assumed that they could achieve the same penetration that they currently have in their home market of St. Louis, then the ultimate potential would be in excess of 5,000. This assumption would not be overly aggressive considering that the St. Louis market is still successfully added units today. There are also many major markets where they have no presence at all yet.

 

The SSS growth goal seems reasonable given their historical performance, pricing power, and ability to get customers to trade up to PNRA overtime. They current do not use electronic media which would add a significant boost to average unit volumes when they decide to pursue it.

 

The operating leverage comes from SSS strength, the franchised business model and their fresh dough facilities.

 

 

PNRA has been growing earnings well in excess of 25% for many years and the average forward P/E multiple has been over 30x. The actual reported EPS growth this year will be below that level given some non-recurring issues like the launch of a major product, some legal expenses and the adoption of stock option expensing. Adjusted for those items though and they would have been over that threshold again this year despite more erratic SSS performance. The lowest that their forward multiple has been over the past 3 or so years has been at about 22x during the peak of the Atkins diet.

 

PNRA is back down to close to its valuation lows at 24x current forward estimates. These estimates are low in my view given the non-recurring items that are included in the 2006 base that analysts are growing 2007 off of. I will breakout those adjustments under the EPS section. PNRA also has one of the cleanest balance sheets in the industry with a net cash position of over $2.00 a share and no outstanding debt. Adjusting for the cash position would drop the P/E multiple by 1 point. Considering that their business model is 2/3 franchised, this capital structure is overly conservative and provides plenty of room going forward to create value as their peers have been doing recently. I.e., levering up to the 3x Debt/EBITDA level that some peers have targeting would allow them to reduce the share count by 1/3.

 

On an EV/EBITDA basis, PNRA is trading at 10x 2007 estimates. This is the same level as slower growing and more levered restaurant companies like Domino’s Pizza.

 

On a FCF basis, PNRA should generate about $50 mil of FCF next year for a yield of close to 2.8%.

 

 

 

After many years of extremely strong SSS performance, trends have been more erratic of late. While performance has been weaker throughout this year, it is almost entirely due to macro factors in my opinion. PNRA’s SSS have been more immune to consumer slowdowns in the past, but the restaurant slowdown we have faced this year has hit the more resilient concepts like SBUX and CAKE. Despite the slowdown, PNRA’s SSS have still been in positive territory and are at the high end for the group. The most recent disappointment for November came as a result of their Midwestern exposure where they have over 1/3 of their units located.

 

Comparisons remain very difficult through Q1 ’07 and then trends should improve. Below are their SSS results for 2005 and 2006.

 

 

PNRA had a major product launch in the 2H of this year called the Crispani which is a gourmet pizza product. The product has had mixed success as far as the market is concerned, but the company is happy with it so far and it will be an important platform going forward. It is currently in 75% of their stores and is provided a 2% lift to SSS vs. projections of 2-4%.

Part of the recent sell off was a result of them guiding down the 2H half of the year due to the weaker than expected SSS and non-recurring costs.

 

Current 2007 estimates are using a base 2006 number of $1.88 and growing that by 22-26% which is the company’s guidance. However, if we add back some of the non-recurring expenses and then assume they grow EPS at the same rate, then EPS would be closer to $2.46 or 7% higher. This is not necessarily my estimate, but is just to show that the current estimate is conservative and could be beat by just normal SSS trends.

 

My calculations on non recurring Q3 expenses related to Crispani.

 

Their comments:

 

225 bps hit on bakery expenses (on COGs, Labor and Other)

50 bps hit from national marketing on G&A

40 bps hit from one time legal settlement

 

The legal issue adds 2 cents

Marketing issue adds another 2 cents

The bakery expense adds 7 cents

 

All this adds 11 cents to EPS for Q3 or 45 cents vs. reported 34 cents

While it is hard to justify a restaurant stock trading at 10x forward EBITDA as a contrarian name, I believe it is. PNRA is down about 14% YTD which makes it one of the very worst performing names in the group on the year. It is one of the very few that is actually trading below historical valuation levels. The focus in the sector has been on fast food names that have had a strong SSS rebound the past few years and investors seem convinced that it will last forever. The rest of the focus in the casual dining space has been on more mature names as investors have looked to financial engineering to create value.

 

Short interest has more than doubled in the past year for PNRA to almost 20% of the float. This makes it one of the most shorted names in the sector.

 

While fundamentals have not been as strong as they have been in the past, it is pretty easy to look ahead 6 months to see the sentiment shifting on this name. A similar situation occurred in 2004 as PNRA was plagued by Atkins fears only to see the stock rise 65% in 2005 (it was basically flat in 2004).