This Pullback Is Just Another Opportunity

Investors in fast-growing companies seem to invest with a shoot-first, ask-questions-later mantra. And earnings results that they might see as terrific at other companies are met with disappointment and frustration. This cycle seems to repeat over and over again, as investors go from wild optimism to a nothing-is-good-enough mind-set. For long-term investors, these short-term pullbacks can spell opportunity, and it seems that is what Panera Bread (NASDAQ: PNRA  ) investors are being offered today.

I wouldn't call this disappointing
One of the primary things investors look for from fast-growing restaurants is strong same-store sales. Companies like Chipotle (NYSE: CMG  ) , Buffalo Wild Wings (NASDAQ: BWLD  ) , and BJ's Restaurants (NASDAQ: BJRI  ) could all be considered competitors to Panera Bread. Each of these companies offers reasonably priced meals, convenience, and its own unique brand identity.

Chipotle and Panera have actually been on similar growth trajectories in the last few years. Both companies have reported strong same-store sales growth, investors bought the shares, and their growth stories seem to be intact. However, a few quarters ago Chipotle reported same-store sales growth that was below investors' expectations, and the stock sold off. However, in Chipotle's last quarter, its same-store sales growth was 5.5%, and investors seemed to forget the past, as the stock sits near its 52-week high.

Panera seems to be getting little credit for its growth, as the company reported same-store sales growth of 3.8%. When you consider that Buffalo Wild Wings reported identical same-store sales growth in its current quarter, you have to wonder why Panera sold off, while Buffalo Wild Wings is soaring. We can take this comparison even further by looking at BJ's Restaurants' same-store sales growth of just 0.4% in the company's most recent results. When you realize that BJ's sells for a forward P/E ratio higher than Panera's, you have to wonder what Panera has to do to impress investors.

Two times second-best
Oftentimes a company can be a great investment even without being the best at everything. In fact, it's nearly impossible to find a company that leads its competition by every measure, so what investors should do is look for a company that performs well across the board. Panera is a perfect example of this, with the second-best operating margin of its peer group, and the second-best free cash flow generation as well.

When comparing restaurants, using operating margin makes more sense than gross margin because each company's product specialization can make gross margins vary widely. For instance, Chipotle relies on beef and chicken, Buffalo Wild Wings relies even more heavily on chicken pricing, and BJ's uses pizza ingredients. Panera's more diversified menu should be a benefit to the company if cost inflation occurs, because it doesn't have to worry that one or two input costs will destroy its margins.

That said, Chipotle outperformed Panera in its most recent quarter, reporting an operating margin of 17.9%. However, if we compare Panera to Buffalo Wild Wings and BJ's Restaurants, you can see the company's margins are very respectable. Panera reported an operating margin of 14.17% compared to 7.88% at Buffalo Wild Wings, and just 5.7% at BJ's.

When it comes to cash flow, Chipotle performed relatively better than its peers, but Panera finished a respectable second. Using core free cash flow (net income plus depreciation minus capital expenditures) helps to even the playing field when comparing companies by eliminating accounting changes that are not real cash. Taking this a step further, comparing core free cash flow to revenue reveals the company that is the most efficient at squeezing free cash flow from each dollar of revenue.

Using this formula of core free cash flow per dollar of sales, we find that Chipotle generated $0.16 of free cash flow in the most recent quarter from every dollar of sales. Panera generated $0.06 using this same calculation, while Buffalo Wild Wings generated $0.03, and BJ's actually produced negative core free cash flow.

Why not just buy Chipotle?
Some of you might be thinking right about now: Why not just buy Chipotle? Given that the company has the best same-store sales of the group, the best operating margin, and the best relative free cash flow generation, this is a fair question.

The main problem with buying Chipotle at today's levels is that the stock already appears to be priced as though Chipotle's dominance will continue. With shares selling for more than 38 times projected earnings, and analysts calling for about 20% EPS growth, the stock sells for about 1.9 times its growth rate. Relatively speaking, both Buffalo Wild Wings and BJ's Restaurants seem to offer a better value than Chipotle. Both companies sell for about 30 times earnings, and are expected to grow EPS by about 18% over the next few years. With both stocks selling for about 1.67 times their growth rate, it seems investors are getting more for their money.

That said, Panera seems like the best value of the bunch. The company sells for less than 25 times projected earnings, yet is expected to grow by about 17.5%. This means investors are paying about 1.43 times the company's growth rate, even though Panera is expected to grow just slightly slower than its peer group. Given that Panera is generating strong same-store sales, has the second-best operating margin and free cash flow generation, it seems this recent pullback is just another buying opportunity for long-term investors.

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  • Report this Comment On August 30, 2013, at 1:04 PM, SkepikI wrote:

    BJ's can be considered to be a competitor to Panera? Really? have you ever been either one?

    I patronize both on occasion, but would never consider them in competition for my $ except in the broadest terms- they both serve food.

    No craft beer at the Panera's I frequent....

  • Report this Comment On August 30, 2013, at 10:07 PM, energeticfool2 wrote:

    I compared CMG with BJRI (using my iPhone App, FairValue with Market Impact) and your numbers make sense to me. But I plan to wait to about $30 before taking a position.

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