Fully Baked Or Great Long-Term Value?

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

I love being right about a stock, but I like it a lot more when I actually profit from being right. Unfortunately, I have been consistently right about Panera Bread (NASDAQ: PNRA), yet I've only made a little bit of money from the stock. I made a classic rookie mistake in that I bought in, watched the stock go up, and assumed once I made a certain amount that it wasn't going to continue to rise. Peter Lynch once said a stock doesn't care who owns it, and there is no predetermined rule that works all the time. He specifically said the old adage of sell when you double your money is particularly foolish (small f), because you miss the chance to make much more. If only I had heeded his advice I would be writing this post with much more money in my account. Panera recently reported earnings that just reconfirmed again what I already knew...this company is wildly successful.

My biggest problem with Panera was it seemed slated to suffer a similar fate to Chipotle (NYSE: CMG). I also owned Chipotle briefly and made some money on it, but then sold before it marched to its all-time high. Starbucks (NASDAQ: SBUX) is another competitor of Panera that I've watched from afar, afraid of its high valuation at times. While there have been times that both Chipotle and Starbucks have gotten ahead of themselves, with Panera I should have taken a longer-term view. If you want a beverage, Starbucks clearly has customer’s mind-share. However, Panera has expanded its beverage menu to attract customers that might otherwise frequent Starbucks. While Chipotle might not seem like a competitor, let me assure you Panera and Chipotle go head to head more than you would think. In fact, there have been many times that I've gone out to get dinner for my wife and I, and she wants something from Panera, but I want a Burrito Bowl from Chipotle. Since both concepts have locations in the same shopping center nearby, they compete every day for diners. The biggest difference between Panera and these competitors is consistency. While Starbucks lost it way, and has recently regained its footing, Panera has been on a pretty consistent march upward. Until recently Chipotle looked like the better growth stock, but with the company's recent fall, the two stocks are more closely aligned at this point. Looking at Panera's earnings, almost everything came up positive, but the company has two areas it can improve upon.

Investors looking for consistent growth need look no further. Panera reported revenue up 17% and diluted EPS was up 28%. All important same-store sales increased 6.2% at company-owned restaurants and 5.5% at franchised restaurants. The company is consistently opening new locations that are both company-owned and franchised. In the last three months, the company opened 17 new stores, and franchisees opened 19 new locations. Panera expects to open a total of about 120 new units for the year. Of the two things Panera could improve on, the first is the company's operating margin.

Panera seems to err on the side of caution when it comes to staffing and location size. This is both a positive and a negative. While this assures that customers won't have to wait in long lines, and the restaurant can seat those who want to eat in, it does hurt margins. In the recent quarter, Panera's operating margin was 11.3%, versus 14.88% at Starbucks, and 16.80% at Chipotle. This is a case where I think Panera management can take a page from its competition. Panera might consider looking at slightly smaller crews or slightly smaller locations to lower costs. This lower operating margin leads to the second area where the company can improve, and that is with their free cash flow generation.

Free cash flow is a critically important measure for any company as it defines what the company makes after capital expenditures. I use free cash flow per $1 of sales to compare companies across the same industry, and by this measure Panera has some work to do. In the last three months, the company generated $0.06 of free cash flow per $1 of sales. By comparison, Starbucks generated $0.09, and Chipotle generated $0.20. While some of this has to do with margins on the type of food and pricing, this is also connected to how much Panera is spending on staffing and occupancy costs. In truth, many people go to Panera for the food, and whether they eat at the store or not doesn't matter like it would at a traditional restaurant. While the company can improve in these two areas, the company's value to investors is already very good.

Panera worried me because of its valuation at different points in the last year or so. However, as we move closer to 2013, the stock looks much more attractive. Management has already increased its 2012 and 2013 estimates for EPS. Based on 2013 projections, the stock sells for about 24 times earnings. Since the company is expected to see EPS growth of over 19%, this isn't too excessive. Chipotle has fallen from loftier heights and investors might consider Panera and Chipotle to be equal values. Chipotle is expected to grow a bit faster, but also sells for a slightly higher forward P/E ratio. When it comes to Starbucks, the company is expected to grow slower than either Panera or Chipotle, but the company's dividend helps their cause. The biggest difference between Panera and their competition? Panera has been more consistent and can improve their margins to make their results even more impressive. Don't make my rookie mistake and assume that Panera has run too far too fast. The company has been the model for consistent growth, and based on next year's projections the stock doesn't look all that expensive either. I would suggest investors add Panera to their personalized Watchlist so they can keep up with this amazing company's performance.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill, Panera Bread, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Chipotle Mexican Grill, Panera Bread, and Starbucks. 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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