Why I Believe Panera Will Outperform

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer too. But some growth stories are inevitably better than others. Hence this regular series. My goal? Out the Fakers, elevate the Breakers, and examine the growth stories stuck in between.

Next up: Panera Bread (Nasdaq: PNRA  ) . Is this fast-casual café growing sustainably enough for your portfolio? Let's get right to the numbers.

Foolish facts

Metric

Panera Bread

CAPS stars (out of 5) ***
Total ratings 1,107
Percent bulls 86.9%
Percent bears 13.1%
Bullish pitches 184 out of 218
Highest rated peers Famous Dave's of America, Yum! Brands, Tim Hortons

Data current as of March 31.

Much as Fools seem to like the concept, those who don't like the stock cite valuation as their key concern. That's understandable. At 35 times trailing earnings and 25 times 2012's estimates, this-fast casual restaurateur commands a premium that bargain hunters are likely to find unappetizing.

Even so, the premium is well earned. In almost every way measurable, Panera is the equal of the Big Dog of the café dining world: Starbucks (Nasdaq: SBUX  ) . Each sports excellent operating and free cash flow margins. Smaller Panera just happens to be growing a lot faster.

Growth is what makes the Panera concept so enticing to me as an investor. Analysts expect the company to grow profits faster than industry average in each of the next two years. Over the next five, Wall Street is calling to earnings to grow 17% annually.

What makes that number is interesting is that it's below what analysts expect from Starbucks. On average, the Street is calling for 18% annualized earnings growth from the coffee king despite its larger footprint.

The elements of growth for Panera

Metric

2010

2009

2008

Normalized net income growth 28% 21.5% 27.9%
Revenue growth 14% 4.2% 21.8%
Gross margin 34.8% 33.2% 31.9%
Receivables growth 17.7% 13.9% (39.6%)
Shares outstanding (million) 29.8 31 30.3

Source: Capital IQ, a division of Standard & Poor's.

So be it. Analysts' emphasis on Starbucks doesn't change the quality of Panera's financial story. This table contains evidence of not only strong growth but also excellent management. Let's review:

  • Growth investors like me love straight-line accelerating revenue growth leading to accelerating profit growth. While growth has proceeded imperfectly it is growth nonetheless. I'd rather see revenue growth accelerating back to 2008 levels, but I also realize that responsible growth matters when 45% of your stores are company-owned rather than franchised.
  • Pricing power is also something we like to see. Or, in lieu of that, excellent cost management leading to higher margins. Here, the news gets better. Panera's menu mix is leading to progressively higher margins on increased volume. Companies that can do that tend to throw off generous free cash flows, so it's no surprise to see Panera among the cash kings of the restaurant business.
  • We also like businesses that collect quickly. Fast collections help produce strong cash flow. And when cash is invested well, it usually leads to higher returns on capital. Panera's ROC has improved from 12% in 2007 to more than 19% today.
  • Finally, Panera isn't diluting existing investors. To the contrary; management has spent $152 million to repurchase shares since announcing a buyback agreement in November 2009. The average buying price? $78.50, or 38% below what the stock trades for today. Co-founder and Chairman Ron Shaich and his team are creating value for shareholders.

Competitor and peer checkup

Company

Normalized Net Income Growth (3 yrs.)

Chipotle Mexican Grill (NYSE: CMG  ) 35%
Denny's (Nasdaq: DENN  ) 39.2%
Einstein Noah Restaurant Group (Nasdaq: BAGL  ) 16.7%
Panera Bread 25.8%

Source: Capital IQ. Data current as of March 31.

Panera Bread isn't the fastest grower in this table but I'm not sure that's a strike against the company. These are excellent businesses, after all. Chipotle, a longtime pick of both our Motley Fool Rule Breakers and Motley Fool Hidden Gems services, is one of the best-performing restaurant concepts on the market.

Grade: Sustainable
And yet if I had to pick another eatery to own -- I already own shares of Chipotle -- I'd likely pick Panera. The concept appeals to a wide audience and is different enough to immediately attract attention when entering a new market. And with just 1,453 stores in the U.S. and Canada, there are lots of markets still left to explore. As such, I've taken a long position in the stock in my Motley Fool CAPS portfolio.

Do you agree? Disagree? Let us know what you think about Panera's menu, strategy, and valuation using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.

And in the meantime, keep tabs on Panera or any of other stocks mentioned here by adding them to your watchlist for free, personalized stock tracking.

Both our Motley Fool Hidden Gems and Motley Fool Rule Breakers services have recommended members purchase shares of Chipotle. Panera Bread and Starbucks are Motley Fool Stock Advisor selections. Tim Hortons is a Motley Fool Global Gains recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Chipotle at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. 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 owns shares of Chipotle, Starbucks, and Yum! Brands and is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


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