Panera Stock: Why It’s Not All That Delicious

Source: http://www.flickr.com/photos/scelera/

Source: http://www.flickr.com/photos/scelera/

On Wednesday, we saw Panera Bread (NYSE:PNRA) shares fall to a multi-year low after reporting weak first-quarter earnings. The company’s profits declined from $48 million in the first-quarter of 2013 to $42 million in the first quarter of 2014. This is despite the fact that revenues grew 8 percent.

Panera Bread isn’t the only restaurant chain that is seeing margin compression — we also saw something similar with Chipotle Mexican Grill (NYSE:CMG). This company reported weaker margins that resulted from rising commodity prices and increased administrative expenses. But at least Chipotle was able to grow its earnings.

Panera wasn’t so lucky. At the same time, Panera’s margin compression could be temporary. The company cites as its justification the fact that while it sold more food, it sold less food per restaurant. This was due to severe weather conditions. On the one hand, I find this a little disconcerting. Severe weather conditions shouldn’t be an excuse, especially for a company that sells coffee and competes with Starbucks (NASDAQ:SBUX), which claimed that adverse weather conditions didn’t impact its business.

source: http://www.flickr.com/photos/9036412@N06/

We must further wonder why the company didn’t cite rising commodity prices as a reason for lower margins — this is a phenomenon that impacts the entire industry, not just a few unlucky companies. Given drought concerns in Brazil — where much of the world’s coffee and sugar is grown as well as California, where a lot of fruits and vegetables are grown — I am surprised that Panera didn’t cite this. Furthermore, if rising commodity prices didn’t impact Panera’s business in Q1, it may impact it in subsequent quarters.

Other than these concerns, I see an opportunity for Panera to improve its operations. Simply put, it needs to shut down less profitable locations. The “weather excuse” aside, Panera seemingly expanded too quickly and in locations where its product isn’t appreciated by consumers. While I wouldn’t necessarily say that the company has saturated the United States, it might be wise to shut down a few of the least productive restaurants and perhaps attempt to open some locations overseas; the company now only operates in the United States and Canada. Were the company to make such an announcement, I would be more confident in its growth potential going forward, and I would be more willing to pay 22-times earnings for the stock.

Another thing investors need to be concerned about is the fact that management has been so aggressively buying back stock. Considering that the shares now trade at a multi-year low it is evident — with hindsight, of course — that these buybacks were not the best use of shareholder capital. I would lke to see the company slow down the buyback and invest in improving its operations, or perhaps pay a small dividend.

With these points in mind, I think Panera has a lot of promise. I think the company offers a compelling product that is inexpensive and gourmet at the same time, while serving as a coffee shop and bakery. Given its emphasis on quality food in small portions, Panera has a leg up on Starbucks — but it hasn’t operated up to its potential.

With that being the case, I want to hold off on owning Panera shares for now. I am not so much waiting for a particular price point as I am waiting for a strategic announcement that answers the question: how is the company going to begin growing the way it was earlier in the 21st century? If the company can do this and demonstrate that it can navigate the competitive restaurant environment, I will buy the shares with enthusiasm. But for now, as the first-quarter earnings figures indicate, Panera hasn’t reached this level of excellence, and it is not worth 22 times earnings.

Disclosure: Ben Kramer-Miller has no position in Panera Bread or in the other stocks mentioned in this article.

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