Panera Bread: Strong Fundamentals Likely To Continue

By Ashish Sharma - July 13, 2012 | Tickers: DNKN, MCD, PNRA, SBUX | 0 Comments

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Panera Bread Co. (NASDAQ: PNRA) is set to report its 2Q12 earnings on July 25^th before the market opens. The company kept up its long tradition of beating consensus estimates and mid-guidance for the 17^th quarter in a row when it reported its first quarter earnings in April. The company posted a diluted EPS of $1.40 in 1Q12 as compared to an expected $1.34. The following chart summarizes the company's EPS track record with respect to consensus estimates and guidance for the last 17 quarters.

Management has also increased 2012 guidance following strong 1Q results. PNRA raised 2012 EPS guidance to $5.58-$5.63 and indicated same store sales at the higher end of the previous 4.5%-5.5% target. We believe management has been conservative with its guidance, as it has been for the last 17 quarters. There is potential for further upward revisions, given that implied EPS growth in 2H12E (near +17%) is below the targeted range for 1H12 (+23-25%), even though cost pressures are easing in 2H12. Following are the other key reasons that make us optimistic about the company’s growth.

Good same store sales momentum: SSS were strong (7.5%) in Q1. The company has planned more marketing spending growth in Q2-Q4 than Q1. The company is also timing its summer salad celebration earlier. This will further impact SSS positively, and PNRA is expected to sustain momentum during the balance of Q2. Importantly, PNRA has yet to see meaningful benefits from its test of national cable television ads, which will likely become an incremental driver longer-term.

Defensive pick even in a slowdown: In a slow-growth scenario, PNRA can be viewed as a safe bet. PNRA has an average check of approximately $9.25, whereas the average check of mid-scale casual chains lies in the $12-$14 range. In case of a slowdown, this will hugely favor PNRA when the customers have to trade down from more expensive restaurants. Its historical performance further strengthens this argument, as during the 2008-2009 slowdown PNRA generated same restaurant sales growth in the 2.5%-3.5% range by gaining customers from mid scale casual dining chains. If there is no slowdown, we believe PNRA can maintain mid-single-digit comp growth.

Commodity inflation to moderate in Q3-Q4: Food costs, driven mainly by wheat, pressured operating margins by ~30bps in 1Q12. With reducing commodity costs, management now expects food inflation of 2.5% for the overall year, down from the previous estimate of 2.75%. The company will benefit from pricing ahead of commodity inflation in the second half of the year, with no plans to give back some of the menu pricing.

Threat from recent moves by SBUX and MCD not significant in the near term: On June 4, Starbucks Corporation (NASDAQ: SBUX) announced it would purchase San Francisco-based Bay Bread and its La Boulange bakery chain for $100 million in cash. The 19-unit La Boulange chain is located exclusively in high-end commercial districts in the San Francisco Bay Area and has an average ticket close to $11. SBUX is likely to roll out La Boulange-branded units at Starbucks in the Bay Area before expanding any further, and it will take at least 2-3 years before the roll out is complete; so there is no immediate threat from this acquisition by SBUX. Also, PNRA offers a much wider variety of breakfast items and has on-site kitchens that further enhance its breakfast reputation over SBUX.

Another potential threat from the quick-service category is McDonalds' (NYSE: MCD) ongoing rollout of an expanded menu of baked goods such as muffins, banana bread, and vanilla scones. But this is unlikely to affect PNRA, as it has successfully withstood previous competitor’s attempts to innovate products (as evident from Subway’s and Quiznos’ unsuccessful attempts to introduce artisan breads into their menus). For McDonald’s, this move looks more targeted at Dunkin' Brands (NASDAQ: DNKN), as we believe they both have similar customer profiles. Also, MCD has reduced its coffee prices (by $1 for any size) in many markets in response to DNKN’s fast geographical expansion.

The company has strong same store sales momentum, no major threat from any competitors in the near term, good historical earnings per share, and strong fundamentals. The company is also a safe bet, even in the case of a slowdown, due to its significantly lower average check than other casual chains. Thus, we recommend it a safe defensive buy.

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