Making a Lot of Dough

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

The quick-serve restaurant category continues to do well, as consumers place a higher value on convenience and speed than quality and service in their fast-paced lives. NPD Group, a data analysis company, estimates that the segment generated roughly $240 billion in sales in 2011 and has grown at a 3% rate over the past ten years.  While the industry’s food has undoubtedly led to sub-optimal nutrition levels and rising health costs, bad habits are hard to break.

The burger wars

The quick-serve segment has historically been dominated by the multi-national hamburger chains, including McDonald’s (NYSE: MCD), Burger King (NYSE: BKW), and Wendy’s (NASDAQ: WEN). These three companies had a combined $31.8 billion in sales in 2011 through a network of 53,000 restaurants around the world.

While Burger King and Wendy’s have had negligible sales growth recently, McDonald’s has been opening stores internationally and increasing store efficiency, with its operating margin rising to 31.6% in FY2011.  In response to consumer demand, the company has also been improving its menu, especially in the McCafe beverages and salad lines. The result has been rising same store sales, up 5.6% system-wide in FY2011, far exceeding the rates for its smaller competitors.

Pave your own way

The quick-serve business is crowded, as any consumer can see during their daily commute.  The industry’s barriers to entry are fairly low -- as is the success rate. Yet Panera Bread (NASDAQ: PNRA) has built a national chain of bakery-cafes by offering a comfortable environment and high-quality fresh food, including breads, baked goods, made-to-order sandwiches, and trademark soups.  Founded in 1981, the company has grown to 1,625 restaurants in 44 states and Canada that serve 6.5 million people each week.  Its locations have become meeting places, where people can enjoy good food and engage in business through one of the country’s largest wi-fi networks.

In its latest fiscal year, Panera reported revenues and operating income of $1.8 billion and $220.3 million, increases of 18.1% and 19.0%, respectively, over the prior year.  It benefited from a 4.9% gain in same stores sales as well as a 29% increase in its catering business.  Despite higher food commodity costs, the company’s operating margins have benefited from declining occupancy expenses and relatively low advertising spending due to its repeat customer base. 

Panera had 9.5 million registered users in its rewards program as of December 2011 and it sends 6.5 million emails each month that provide personalized rewards based on previous purchase patterns.  The result has been a lesser need for ad campaigns, with annual media spending running at 1-2% of sales compared to 3-5% at other national chains.

Looking ahead

In FY2012, Panera has continued to produce strong results, with increases in revenues and operating income of 17.5% and 26.5%, respectively, versus the prior year period.  Its operating margins continued to benefit from a larger store base and comparable sales were up 6.0% for the period. 

The company has had a strong ability to increase prices at a low single digit rate for a number of years, due to its loyal customers and quality food offerings that includes the new Thai Chopped Chicken Salad and Wild-Berry Smoothie.  Panera has already exceeded its goal of opening 115-120 restaurants in FY2012 and it expects to open a similar number in FY2013. 

Despite its premium 28 P/E multiple at recent prices, Panera is a “healthy” choice for investors’ portfolios.

rghanley owns shares of Panera Bread. The Motley Fool owns shares of McDonald's and Panera Bread. Motley Fool newsletter services recommend Burger King Worldwide, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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