Three Fast-Casual Sandwich Companies, One Winning Investment

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fast-casual concept has proven itself with Five Guys, Chipotle, and Panera (NASDAQ: PNRA) emerging as the early winners (and Chipotle and Panera as multi-baggers for those with enough foresight or luck to invest in them early). This article is for the rest of us (including myself): we missed out on the initial wave, so where should we put our money?

I will be writing two articles to cover this growing sector: one on the sandwich end of fast-casual (Panera, Cosi (NASDAQ: COSI), and Einstein Noah Restaurant Group (NASDAQ: BAGL)), and one on the burrito end (Chipotle, Jack in the Box’s Qdoba, and Fiesta Restaurant Group’s Taco Cabana and Pollo Tropical concepts). Let’s start with the sandwich stocks.

Given its overall dominance and excellent financials, Panera is an obvious buy. Einstein Noah Restaurant Group also has a compelling story, and with some growth in profitability could be a nice income stock. I would personally stay away from Cosi because it's too risky, although it has a management team dedicated to establishing profitability – and if they pull it off, Cosi could be another multi-bagger. We'll look at Cosi first.

Cosi

Cosi is easily the most speculative of these stocks. It has the smallest footprint and therefore the best potential for further expansion, but its financials are brutal. Revenue has steadily declined for the past five years, from $136 million in 2008 to $98 million in 2012 (and $95 million for the trailing twelve months, according to Morningstar). Cosi did not post a profit during this time span. Same-store sales for the first quarter of 2013 were down a whopping 6.6 percent compared to the first quarter of 2012. In short, this chain is in serious trouble.

And yet, it’s possible that things will turn around. Management is making changes, including a smaller menu, a redesigned interior, and more efficient food preparation. Management has also implemented a good triage policy of franchising or closing company stores in their non-core markets. This demonstrates Cosi’s focus on profitability first – removing lesser-performing restaurants from its corporate portfolio to focus its spending on improving the restaurants with the best chance of making more money. These positive steps may generate a leaner, possibly profitable Cosi. I want to believe in it, but the numbers just don’t add up right now for a positive ending. If you invest in Cosi right now, it will be a gamble. There are better options for your money.

Einstein Noah Restaurant Group

Einstein’s management is pushing a value strategy, with new $5.99 lunch options and $3.99 breakfast combos. I worry that this may result either in sacrificing margins (as seems likely, given the decrease in earnings before interest, taxes, depreciation, and amortization in the first quarter to $10.4 million from $11.5 million for first quarter of 2012) or a lowering of quality in exchange for sales volume. Losing the margins will decrease profitability directly; a reduction in quality may ultimately cost Einstein the customer volume they are seeking. Einstein is also pushing premium sandwiches at higher price points, which may balance those margin losses. All of that aside, management is making some good moves - Einstein has increased its specialty beverage sales (up eight percent in the first quarter) and is growing its franchise base (the company reports 136 franchise stores in the pipeline.) Even with this focus on franchises, Einstein will still be opening 15-20 new company stores in 2013, as well as 30-40 new licensed restaurants.

The financial front shows reasonable – if unspectacular – results. Earnings-per-share declined from $0.74 in 2012 to $0.69 in 2013. Gradual increases in revenue over the past four years were balanced by steady decreases in operating margin over the same time period. Same-store sales were down 0.6% for the first quarter of 2013 compared to the first quarter of 2012.

The company also pays a 3.5% dividend. Given a payout ratio of 72%on the dividend, it may not be sustainable. Additionally, the company is carrying a lot of debt: the debt-to-equity ratio is 4.2, according to Morningstar. This will hamper future growth and explains why the company is focusing on franchise expansion – franchises don’t require the sort of capital investment that new company stores do. That debt is a big red flag, but the company is making the right moves to avoid growing its debt load. On balance, Einstein seems to be a good investment for the longer-term (and if the dividend survives, it will be a good income stock as well.)

Panera

Panera is quickly growing profits, with earnings-per-share jumping from $4.55 in 2011 to $5.89 in 2012 and revenue climbing from $1.8 billion in 2011 to $2.1 billion in 2012. Earnings-per-share for the first quarter of 2013 was $1.64, a significant increase from the earnings-per-share of $1.40 in the first quarter of 2012. Panera saw a 3.3% increase in same-store sales between the first quarter of 2012 and the first quarter of 2013.

Panera opened 10 new company bakeries and 12 new franchise locations in the first quarter of 2013 alone; at that rate, Panera will open about twice as many company and franchise restaurants in 2013 as Einstein. Panera has a great balance sheet, with $323 million in cash and no debt. Even so, it trades at a reasonable price-to-earnings ratio of 30.2 based on earnings from the trailing twelve months and a forward price-to-earnings ratio of 22.6, according to Morningstar. This company combines some very attractive investment traits including dominance in its market, superb expansion, and same-store sales growth.

Final thoughts

Cosi has a compelling underdog story that may pay off very handsomely for its investors, but its financials are all trending in the wrong direction. Wait to invest until management’s programs have more time to show results. Einstein is a solid investment – it will be hampered by its debt load in the coming years, but it still has growth ahead.

Panera, however, is the obvious choice – it trades at a significantly higher price-to-earnings ratio than Einstein (30.2 for the trailing twelve months, compared to 20.7 for Einstein) because despite having by far the largest footprint of these three, it is the company that is most acting like a growth stock. Management is focused on growing the business quickly and profitably, and not just by opening new bakeries. Same-store sales growth is also impressive at Panera, surpassed only by the Pollo Tropical concept run by Fiesta Restaurant Group which recorded same-store sales increases of 3.8 percent. Buy Panera now; consider Einstein for the income and moderate growth, and wait on Cosi.

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Michael Douglass has no position in any stocks mentioned. The Motley Fool recommends Panera Bread. The Motley Fool owns shares of Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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