Battle of the Bagels

By Brian Shaw - August 13, 2012 | Tickers: DNKN, BAGL, PNRA, SBUX | 0 Comments

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Breakfast has become big business for restaurants in recent years.  With constant pressure to increase same store sales and increase market share, companies have expanded the range of menu choices.   Let’s take a look at how four companies started with different restaurant concepts and unique menus that have slowly expanded until they’ve reached a convergence: the bagel.

The bagel is a breakfast choice that has long been associated with small locally owned bakeries.  If you search for the top 10 places to get a bagel in your hometown, you likely won’t get many results that are owned by large corporations.  The largest public chain of bagel shops, including Einstein Bros., Manhattan Bagel, Chesapeake Bagel and others, is Einstein Noah Restaurant Group (NASDAQ: BAGL).  Einstein started as a simple coffee and bagel shop similar to many locally owned competitors.  Since feeling the effects of competition around it, Einstein has been forced to add sandwiches, salads, pastries and other items to its menu to stay competitive.  The results have been promising, with five quarters of positive same store sales results as noted in last week’s earnings release. 

Part of the reason that Einstein felt its competitive position erode in recent years is the rapid expansion of Panera Bread (NASDAQ: PNRA).  Panera quickly morphed the bakery concept, a catering business and fast causal dining into a restaurant chain that is successful at breakfast, lunch and dinner across its roughly 1,600 stores.  Management continues to grow the company aggressively thanks to its healthy net cash position, as evidenced by its most recent quarterly results, which included greater than 20% earnings growth for the ninth time in the past 10 quarters.  Panera is just beginning to hit its stride in its growth cycle, with analysts estimating growth to 4,000 domestic locations over time. 

Starbucks (NASDAQ: SBUX) started off as simply a place to get coffee.  More recently, the company has expanded its beverage range, added pastries, baked goods and gifts, and currently has around 18,000 locations worldwide.  Starbucks has deployed its massive scale and healthy balance sheet to deliver further growth in distribution (from food service to K-Cups), new concepts (like Evolution Fresh juice bars and Starbucks Refreshers energy drinks) and further location expansion.  The potential impact on these growth initiatives should not be underestimated; for example, Starbucks plans to expand its presence in China from 570 stores earlier this year to over 1,500 stores by 2015.  

Another player converging on the breakfast market with bagels is Dunkin’ Brands (NASDAQ: DNKN).  Famous for its donuts and other tasty (and unhealthy) treats, Dunkin’ has translated the popularity of its coffee into a strong competitor with bagels, pastries, breakfast and lunch sandwich options.  Since its IPO just over a year ago, Dunkin’ has been focused on using its newfound independence to grow both of its brands -- Dunkin’ Donuts and Baskin Robbins -- domestically and internationally.  Considering the fact that the northeastern United States is the only market that Dunkin’ considers to be reasonably penetrated, there is lots of room to expand; in fact management believes that it can more than double its store count in the United States alone to 15,000.  Standing in the way of this expansion, however, is approximately $1.4 billion in debt, which represents a roughly 4.1x leverage ratio.

With all of these competitors converging on directly competing menu options like bagels and coffee, here’s a look at how these companies are valued relative to each other:

Which to Buy?

This table helps identify the unique features of each company’s stock performance and valuation.  For Einstein, management’s announcement in May that it is exploring strategic alternatives resulted in a jump in share price that minimizes likely upside from this point onward.  Dunkin’ has a lot going for it, but the cloud of debt hanging over it will make it more difficult to execute its growth plan without further leveraging or diluting shareholders.

Meanwhile, Panera and Starbucks have clearly led the pack in terms of generating returns from shareholders over the last few years; the sizable cash positions and ambitious growth plans of both companies make it hard to see what will stop them from achieving growth going forward.  For both, the present valuation represents a reasonable premium for these growth opportunities and may in fact be conservative if you believe that an opportunity like Starbucks’ Evolution Fresh concept or potential expansion of Panera internationally will add material value to each company.  

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