3 Risks for this Restaurant

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

If you’ve followed Panera Bread (NASDAQ: PNRA) this last week, you’ve watched the stock surge after beating analyst estimates for both revenue and net income. As I mentioned in a previous article here, Panera has a lot of upside for investors. That said, there’s always risks.

NBA great Charles Barkley recently notedthat  “Father Time is undefeated.” That statement holds especially true with companies and stocks. Markets mature, consumer tastes change, and if companies can’t continue to adapt and innovate, they will fail over time. It’s incredibly difficult to stay on top, as the ever-increasing turnover in the ranks of the Fortune 500 proves.

For Panera specifically, what challenges must management face to get on top of the restaurant industry and stay there? Taking a look into Panera’s 10-K, here are 3 of the issues and explanations the company provided:

1. We may not be able to continue to convince our customers of the benefits of paying our prices for higher-quality food.
This year's severe drought has increased food prices. Panera’s margin and success depends on passing the costs of quality ingredients on to consumers, which requires Panera's marketing campaign to educate customers about the quality of the food. Easier said than done. Below are tables of Panera and competitors, McDonald's (NYSE: MCD), Chipotle Mexican Grill (NYSE: CMG), and Buffalo Wild Wings (NASDAQ: BWLD). Let's compare their operating and net margins to see which companies are controlling costs for higher margins.

All competitors have been consistent with their top and bottom lines as well as their margins; that’s a good sign. Chipotle has the slight edge over Panera, which emphasizes that Chipotle's more efficient at this point. Buffalo Wild Wings' margins are highly sensitive to the price of chicken, which has increased due to the drought. McDonald's looks like a juggernaut here, with net margin nearly equaling Panera, Chipotle, and Buffalo Wild Wings combined. This is why Panera lists its pricing power as a risk factor. The company must convince consumers that quality ingredients are worth paying an extra few dollars more than their competitors charge.

2. Disruptions or supply issues in our fresh dough facilities could affect business operation costs.
Next, let’s look at Panera’s operations and why they're costly. The company operates 22 fresh dough facilities, which service all of its stores in the U.S. It delivers fresh dough and other products daily with an average distribution range of 300 miles. However, if there are weather disruptions or fleet problems, that mileage can increase to as much as 500 miles.

It’s easy to understand how a small increase in gas prices could raise the cost for daily operations. If maintenance or faulty equipment causes facilities to close, miles traveled for operations can drastically increase. Consumers must understand, and be willing to pay up for, the cost of fresh bread baked daily. Panera must also strive to maintain efficient distances and delivery schedules.

3. Competition may adversely affect operations and consolidated results of operations.
Investors see a lot of potential in Panera, as evidenced by the premium price paid for its stock. With a P/E ratio hovering around 30, Panera must continue to grow in multiple ways. It must increased same-store sales while opening new units. The new units opened will need to increase year over year to sustain the high valuation.

This abundance of new stores and brand presence will only increase the amount of competition Panera faces abroad. The restaurant industry is highly competitive over location, customer service, price, taste, and quality.

McDonald's is the juggernaut of cheap, fast food. Focusing on convenience over experience, the Golden Arches continue to succeed globally. Chipotle and Panera compete on a more level playing field. Panera has successfully aimed for consumers who are more interested in a better experience and atmosphere. Chipotle aims a little lower, with higher-quality food but more convenience and speed. Buffalo Wild Wings focuses on a sports-bar-and-grill feel, and does so extremely well. There aren’t too many places I’d rather be for sporting events than Buffalo Wild Wings, as it enters a busy sports season.

Bottom Line
Panera has done extremely well over the last couple of years, giving investors great returns. It has a bright future, but one still fraught with difficult challenges. Convincing consumers to pay more for a premium product is never easy. Growing at an increasing rate to justify lofty valuations is a difficult hurdle for any growing company. Competition is fierce, and that will never change. I believe Panera possesses the management and brand name to bring successful returns into the future, but we’ll see whether the company can beat Father Time.


dmiller5350 has no positions in the stocks mentioned above. You can follow Daniel on Twitter @StreetSmartFool. The Motley Fool owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, McDonald's, and Panera Bread. Motley Fool newsletter services recommend Buffalo Wild Wings, Chipotle Mexican Grill, McDonald's, 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.If you have questions about this post or the Fool’s blog network, click here for information.

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