Why I still like Panera Bread (PNRA)

Summary: Buy point: $65 (if you get a chance) Thesis: Stronger-than-expected growth for years to come

I'll admit, I'm late on this post. Call it "fashionably late" because I'm still here before the next same-store sales update in April. Hey, I don't get paid to do this stuff (yet) and I have real committments at the University of Wisconsin.

With my spring break travel plans getting foiled at the last minute, last week I read the new Panera 10-k and updated my revenue/earnings/valuation model. It's not all I did, I had an internship interview and the NCAA tournament was on at the end of the week so I saw some couch time (The Badgers lost big, but hey, there's always next year).

At any rate, my initial thoughts were that the Panera dough ball is rolling downhill - in a good way. It's not taking much effort for this little restaurant company to achieve that one-in-a-thousand success that few companies can find. In restaurants, I'm not sure we've seen this since Starbucks (SBUX). Perhaps the most interesting thing that was said on the latest conference call is that when McDonald's (MCD) advertises healthy salads, Panera sees its traffic increase!

The Good Panera has carved out its niche among chain restaurants nationwide. It has strong breakfast, lunch, dinner, catering, and take-home bread businesses. Not many restaurants can make such a claim. In fact, I'll bet you can't name ONE. That's the beauty behind this place - it's successful in all these businesses and yet does not compete on price. Panera gets to charge its customers a premium because its clientele are willing to pay its higher prices for higher quality food.

And yet, it seems like it's so simple to duplicate. Walk into any Panera store and the place looks eerily similar to Atlanta Bread Company (private company, smaller chain) or Cosi (COSI, unprofitable). Or maybe it looks like your local trendy coffee shop. So why can't other companies copy what they've done?

• The brand and food - With 877 stores in the US, Panera is now big enough such that consumers can travel to other cities and still have an idea of what they'll get. And it's tasty, quick, and healthy (if you want it to be)
  
• Management has played the game before - The CEO, Ron Shaich, has "been there done that" with former franchise Au Bon Pain. He's seen what The Street likes and dislikes, and knows that the suburbs are where the money is in this space. This is perhaps why Cosi is struggling. He also understands what it means to actually visit sites and listen to what customers want.
  
• Menu innovations - The Via Panera catering business is perhaps the best example of a Panera innovation and in its 2nd year of existence, it already represents 4.5% of revenues. At the current moment, they are piloting a flatbread pizza offering, called a Crispani. Even when the Atkins diet peaked in 2003, Panera did what it could to keep health-conscious customers happy by developing low-carb items and its top-line still grew by 25% Not bad for a "bread" company.

The Bad The picture isn't completely rosy. This time around, the "risks" section was three times larger than the last 10-k. Oh, but we want real analysis, not just qualitative mumbo-jumbo like that, right? At any rate, the company did go much more into detail about potential risks. Heck, they even mentioned bird-flu as a possible risk. Would bird flu sink Panera's stock? I am not so sure, because after all, this is about the last restaurant that comes to mind when I think about chicken - it's not Panera Chicken company. I have yet to see them really advertise the chicken, despite the fact that the anti-biotic free chicken has been a big piece of discussion in the K's and Q's, plus conference calls. Fortunately, suburb eater-outers aren't reading these reports in the masses! Still, it's hard to know what could happen to PNRA if bird-flu becomes a major US issue.

My biggest concern has to do with ownership of the stock. First, management does not own an overwhelming portion of Panera's shares. CEO Shaich owns the rights to roughly 5.2% of the common shares, and holds 93% of the preferred shares (14% of voting rights). Overall, management has the rights to roughly 7.1% of the shares. Second, major funds like Capital Research (American Funds), Fidelity, and Baron have been selling shares. Capital unloaded nearly 50% of its stake early last year. This leaves me to wonder who has been buying lately to push the stock higher? Have momentum investors been buying? This could mean that PNRA may fall hard on any kind of unexpected news and cause some bloodiness in a portfolio. Of course, this could mean an opportunity :-)

In terms of earnings there is still some correlation to gasoline prices. Restaurant trends could somehow see consumers shift to other kinds of food that isn't healthy, fresh, or quick, or suburb dwellers could stop eating out altogether (but these seem unlikely right now). Furthermore, the company has decided to significantly increase its amount of self-insurance against workers health and injuries. Finally, with 60+ stores in Florida alone, a major hurricane could have a significant short-term impact on PNRA results (weather issues in general could have impact if geographically pertinent). There are always other risks, too, but these come to mind before any others.

The Bottom Line My target price for Panera is $85. There is enough pessimism towards PNRA's longer-term growth prospects which is causing the shares to be undervalued, despite its huge gains. This presents a scenario where PNRA can continue to exceed expectations. With that being said, PNRA is a fairly volatile stock and I'm looking to May which I believe could be a tough month for Panera to come out with a big same-store sales growth number. Could a "slip up" in May lead to an incredible buying opportunity? My analysis shows that below $65 is a great place to add PNRA because the reward-to-risk ratio would be extremely favorable. At $73 the stock is worthy of a small position, and if PNRA can find $65 consider it a gift.