Fool on Call: Panera Bread's B-Minus

Panera Bread's (Nasdaq: PNRA  ) stock has retreated from 2006's all-time high of around $76; it now sits at $57 and change. Will shareholders have an opportunity to see their investment retest its highs in the near future? Panera's quarterly earnings conference call may be our best chance to find out.

The latest call is particularly useful, since it covers Q4. End-of-fiscal-year calls often give us a solid understanding of what transpired over the past four quarters, and what we can anticipate in the next four.

In this edition of Fool on Call, the first part of our discussion will look at 2006; then we'll turn our attention to 2007.

Eating lunch elsewhere?
For any restaurant investment, store expansion is critical to driving top-line growth. Witness Panera's competitor Starbucks (Nasdaq: SBUX  ) , which saw fourth-quarter sales from units open for more than a year increase 6%, while revenues for the entire company grew by 22%. New store openings drove the double-digit top-line increase, which may explain why Starbucks is opening eight new stores per day so far in 2007.

This truism becomes abundantly clear as we look at Panera's full-year metrics. The company opened 155 new bakery-cafes in 2006, for 17% growth in unit expansion. Considering that 2006 same-store sales grew by just 4.1%, while net sales rose by 29%, new store openings clearly fueled much of the growth.

Panera's 2006 comps merit a closer look, since CEO Ron Shaich expounded upon them in his prepared remarks. The company kicked off the year with solid 9% growth in comps, but by Q4, that growth had fallen to just 2%. In total, the 4.1% comps in FY2006 were a dropoff from the 7.8% mark Panera achieved in 2005. The downward trend raises the question, "What's going on?"

Shaich first set out to debunk the myth that the decline stemmed from the introduction of Panera's Crispani pizza. Though Schaich admitted that "Crispani sales are not meeting our highest hopes and expectations," he added that Crispani is doing just fine, and suggested that without the pizza, evening sales would have really struggled.

For Shaich, the problem wasn't the pizza or the evening portion of Panera's sales day, but the afternoon timeslot. For the past three quarters, management noticed that lunch transactions began to wane, and Schaich admitted that executives aren't sure why.

He did offer a couple of possibilities, including a weaker consumer environment and "less-intense management focus on lunch and difficulties maintaining the excitement" Panera garnered in 2005 with its introduction of antibiotic-free chicken. The latter argument is compelling, but I find the former lacking.

Panera may have experienced a weaker consumer environment, particularly around the lunch hour, but competitors certainly didn't. Perhaps those other concepts are starting to nip at its business. Starbucks has slowly been increasing its warm lunch menu options, while McDonald's (NYSE: MCD  ) , once known just for fries, burgers, and sodas, is transforming itself into a place for salads, wraps, and premium coffee. Simply put, consumers have more options for lunch than they did just a year ago, and it's putting the hurt on Panera's business.

Bringing customers back
Shaich posed the obvious question, "So what are we doing to boost lunch transactions?" He is confident that lunch transactions will turn positive in 2007, so long as management can carry out a few key moves.

First, Shaich announced a "systemwide commitment" to a renewed operational focus on lunch. Second, Panera is planning to introduce new salads, sandwiches, and paninis. And third, the company will emphasis improving the accuracy and speed of its service.

If lunch does improve, 2007 comparable same-store sales could come in higher than the currently projected 2% to 4% range. Let's assume that Panera only manages to hit the top end of its range; when we couple that with roughly 18% unit growth, shareholders should once again see solid growth in the 20%-plus range. Earnings per share are also expected to increase 23% to 27% in 2007.

Making the grade in 2007?
I appreciated CEO Ron Shaich's candor in the call. "I have to give ourselves a big B-minus," he said of the company's 2006 performance, "because, frankly, the year was just too choppy and just too painful for our investors and for us."

This time next year, will Shaich be giving his team an "A"? We'll get an early indication at the close of the first quarter. Based on Panera Bread's historical performance, I wouldn't count on either the company or its stock to remain in the B-range for long.

For related Foolishness, see the following articles:

  • Is it time to nibble on Cosi (Nasdaq: COSI  ) ?
  • Panera was soggy last quarter, too.

Starbucks is a Motley Fool Stock Advisor recommendation. Take a 30-day free trial and see the stocks David and Tom Gardner have recommended to subscribers since 2002.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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