A Bad Second Quarter Yields Great Opportunity

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

Panera Bread's (NASDAQ: PNRA) earnings came in under expectations for the second quarter of 2013, and the sell-off to under $180 gives you a great opportunity to, as Warren Buffett put it, be “greedy when others are fearful.” There is nothing wrong with Panera’s business plan, and the market’s irrationality is your opportunity.

Solid revenue and earnings

Panera reported second-quarter 2013 EPS of $1.74, representing growth of 16% from EPS of $1.50 reported in the second quarter of 2012. Expectations from Wall Street were $0.05 higher – but to my mind, 16% growth in EPS is still a great growth story. It certainly compares favorably to Panera’s closest competitors in terms of product offerings, Cosi and Einstein Noah Restaurant (NASDAQ: BAGL). Cosi reported a loss of $0.15 per share last quarter, a further decline from the $0.08 loss of second quarter 2012. Einstein Noah reported EPS growth of 12% (from $0.17 to $0.19) year-over-year. Panera’s revenue jumped 11%, as compared to Einstein Noah’s 2% growth and Cosi’s 12% revenue decline.

A note on comps

Same-store sales grew by 3.7% (including a 0.5% loss in number of transactions), which puts Panera solidly in the middle of the fast-casual pack. Cosi and Einstein Noah both posted worse comps for the quarter (-6.6% and 0.7%, respectively). Panera also delivered higher comps than every quick-service concept except for Popeyes.

Also, the 0.5% loss in Panera’s number of transactions was offset by the growth in entrees per check – if more entrees are being sold per check, it may indicate that more people are eating together on one check. This suggests that “the number of people…visiting Panera is up,” per co-CEO Ronald Shaich.

With increasing competition in the food categories (resulting in offerings like Einstein Noah's Everyday Value $5.99 combos), food margins will decline, and specialty beverage sales will be a big part of future comp growth for all three companies.

Expansion

Panera opened 37 new stores in the second quarter, and management anticipates 115 to 125 new stores this year. In fact, Roger Matthews, the executive vice president, hinted on the second-quarter earnings call that Panera may even exceed that guidance. Einstein Noah, by contrast, opened seven new stores in the last quarter, and management anticipates between 60 and 80 new stores for the year. The majority of these stores will be franchised or licensed.

Given Einstein Noah's heavy debt load (the company's debt/equity ratio is 3.8), the lower risk and capital needs of franchising represent a solid way for management to promote long-term growth, even if the number of restaurants opened is significantly smaller than Panera's.

The MyPanera program has 14.5 million members, up from 11 million at the end of second quarter last year. In an increasingly competitive restaurant sector, investments to drive customer loyalty are key. Cosi and Einstein Noah do not have loyalty programs.

Compare to another great company

Panera easily laps its most obvious competition, so let’s take a look under the hood of the fast-casual firm whose price jumped almost 10% on its second- quarter earnings news - Chipotle Mexican Grill (NYSE: CMG).

Chipotle reported comp growth of 5.5% (better than Panera), 18% revenue growth (better than Panera), and 10% EPS growth (less than Panera). The quarter was better for Chipotle, but not that much better – not enough to justify the gain in Chipotle’s stock and the loss in Panera’s based on both companies' earnings. Chipotle trades at a much loftier valuation, with a P/E of 42.7 based on earnings from the trailing 12 months, as compared to Panera’s 27.5.

Great investments

All that said, there are some very good reasons to be bullish on Chipotle, aside from the great financials the company reported - after all, it's the long-term business model that counts. Management has decided to follow other firms like Starbucks and Whole Foods Market by marketing to socially and nutritiously conscious consumers with Chipotle's newly-strengthened Food With Integrity Program. Chipotle now labels genetically modified organisms (GMOs) in its food and is seeking to eliminate all GMOs from its product line.

The roll-out of the Sofritas vegan tofu option in California (and soon in select other markets) marks another branch for potential growth. With these offerings, Chipotle will continue to fortify its position with millenials, who favor companies they view as socially responsible. Millenials are generally at the early end of their earnings (and spending) potential given their age and the labor market - as they age, their spending will drive profits for firms like Chipotle.

Final thoughts

Panera was unfairly punished by a short-sighted Wall Street, which had unreasonable expectations for earnings. The business is growing rapidly in revenue, earnings, and new stores, and now it’s available for (comparatively) cheap. Chipotle is a little more expensive, but it is also a great long-term holding.

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Michael Douglass has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill and 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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