How This Bakery Chain Plans to Conquer the Fast Casual Space

The rapid revenue growth and high profitability of Panera Bread (NASDAQ: PNRA  ) , a bakery-cafe operator specialized in breakfast items, shows that making bread, bakery products and sandwiches is still a great business despite the presence of big players in the space, such as Starbucks  (NASDAQ: SBUX  ) .

Panera has performed well despite increasing competition from both fast casual restaurants and coffee-focused chains. Last year, with fewer than 1,600 locations, Panera was actually responsible for 13% of the $31 billion made in the domestic fast-casual restaurant market.

PNRA Revenue Quarterly Chart

Source: YCharts

Considering Panera's healthy menu, its relatively low number of locations, and the fact that the U.S. population is increasingly aware of health issues, this could be only the beginning of a great growth story. But how does Panera plan to keep growing at the same high speed? And more important, what competitive advantages does the bakery chain have in order to protect its business from aggressive competitors?

Strong competitive advantages
Despite heavy competition, Panera has several key competitive advantages. First, to stabilize its cash flow, Panera uses long-term franchisee agreements. According to Morningstar, the franchisees pay more than 5% of gross sales from each store to Panera.

Notice that Panera's management keeps a healthy balance between the number of company-owned stores and the number of franchised stores. As a result, Panera may have better risk management, and it may be able to expand faster than Noodles & Co. (NASDAQ: NDLS  )  which owns most of its restaurants.

Management is also constantly innovating both Panera's menu -- for example, by including pasta this year -- and its service. For example, Panera was the largest provider of free wi-fi in the U.S. in 2006 and 2007.

Panera also excels at restaurant efficiency. Restaurant contribution margin for the bakery chain is among the highest in the industry at 22%. High margins and an active share repurchasing program allowed Panera to grow its earnings per share by 16% to $1.74 last quarter, well above Starbucks' $0.55 EPS record.

From a menu perspective, Panera offers a wide selection of top-quality sandwiches, pasta and bakery products. This menu is both unique and healthy, like competitor Noodles' menu. Panera can therefore take advantage of the fact that Americans in general are becoming more aware of what they eat.

To add more "freshness," Panera also provides customers with a comfortable space with an attractive interior design, sometimes even providing a fireplace. Panera's menu selection is as wide as Noodles', and Panera's decor concept is impressive in comparison with other fast-casual restaurants. It resembles a cozy coffee shop. As the company puts it, "it's an oasis where people come when they want to visit friends, hold an informal meeting or just enjoy some alone time." This concept allows Panera to also attract coffee lovers, who make a huge market where even a company as big as Starbucks, with more than 11,000 locations in the U.S., keeps finding amazing growth opportunities.

Due to the richness of its menu, Panera isn't particularly exposed to fluctuations in coffee prices, which are now less than half of their 2011 high. Starbucks, on the other hand, is very exposed, but its management has successfully developed both strong branding and influence over coffee bean suppliers. This allows Starbucks to not only maintain high prices on its store-brewed coffee, but also to ensure access to raw materials at very competitive terms.

Also notice that despite offering a wide menu, Panera has a special focus on bakery and bread products. Specializing in a certain dish, cuisine or ingredient is a very smart strategy in this industry. By attracting customers in love with that particular component, the restaurant is able to build out a loyal customer base at an early stage. This strategy is also being used by Noodles. By attracting noodle-lovers, the company has managed to build loyalty among its customers very fast. Approximately 40% of Noodles customers visit the restaurant at least once a month.

Final Foolish thoughts
Several competitive advantages should help Panera keep expanding its business. Just in the latest quarter, the company opened 37 new bakery-cafes. New company-owned cafes had average weekly sales of $50,983, a 5% increase from last year. More importantly, Panera is exposed both to the attractive fast casual space and to the vast coffee market.

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