Can Panera Bread Drive Some Momentum With a Menu Upgrade?

Source: Panera Bread.

Leading restaurant chain Panera Bread (NASDAQ: PNRA  ) has risen to the top echelon of the fast-casual category by offering quality food at a reasonable price. The chain has won over customers with its trademark artisan bread and made-to-order sandwiches. However, 2013 was a relatively lackluster year for the company; comparable-store sales growth downshifted due to customers' changing palates and operational issues at its stores. 

In response, Panera has invested in more store manpower and engineered a menu overhaul. This includes new baked-good offerings with sprouted grains, a higher-protein grain that has gained a following among the health-conscious crowd. So, is Panera a good bet at the current price?

What's the value?
Panera has built a national footprint of stores, more than 1,700 at last count, by one-upping the fast-food chains. It offers on-the-go customers more nutritious food choices at an affordable price, as evidenced by an average check of $9.39 as of 2012. The company's favorable value proposition has allowed it to nearly triple its store base over the past decade while creating a loyal stream of customers, including roughly 15 million members in its MyPanera loyalty program. The customer loyalty has also limited Panera's need for heavy marketing expenditures, allowing it to consistently post double-digit operating profit margins.

In its latest fiscal year, Panera continued building on its multiyear growth trajectory, albeit at a reduced rate. It reported a 12% top-line gain that was aided by both a further expansion of its store base and a comparable-store sales gain, its 14th consecutive year of positive gains. The company's average store profitability slipped during the period, though, a result that management attributed to inefficient work processes and insufficient manpower in its stores. 

While Panera has begun to rectify the situation by having "more hands on deck," the higher management costs seem likely to offset any productivity gains. This will make a higher store profitability level difficult to achieve.

Benefiting from others' misfortunes
Of course, much of Panera's growth has come from its ability to poach customers from the struggling casual-dining chains, like Darden Restaurants (NYSE: DRI  ) . Darden's portfolio of brands, including Olive Garden and Red Lobster, have generally struggled lately. This is due to falling customer volumes, as its price-conscious customers have anecdotally searched for better value and healthier fare elsewhere.

Darden's financial results have continued to be poor in FY 2014, highlighted by a 28.2% decline in its adjusted operating profit. This led it into a current companywide restructuring of its operations, including workforce reductions and a proposed spinoff of its Red Lobster unit. The company has also been pursuing an expansion of its menu into lighter and healthier fare, especially at its Olive Garden unit, moves that are pretty clearly designed to stem the outflow of customers to the fast-casual chains.

A better way to go
Naturally, Panera is looking to keep its business momentum going. It's doing this primarily through a further refresh of its menu, including new entrants like its antibiotic-free roasted turkey offerings. The company is also planning to increase its media spending, with plans for a broader television campaign in 2014. 

However, given Panera's flatlining comparable-store sales trend, investors should probably take a pass on the company in favor of the best-of-breed in the fast-casual category, Chipotle Mexican Grill (NYSE: CMG  ) . Like Panera, Chipotle has found significant success by leveraging off its mission of providing on-the-go customers with healthier fare at a reasonable price, a strategy that has led to fast growth and a coast-to-coast store base.

More important, Chipotle utilizes a very simplified menu compared to Panera's more extensive offerings. This operating model allows Chipotle to efficiently utilize its manpower, as evidenced by much lower labor costs as a percentage of sales. The net result for Chipotle is a higher operating margin and cash flow yield, thereby providing ample funds to power its store-expansion plan, expected to add nearly 200 stores in FY 2014.

The bottom line
Panera is making moves to enhance the customer experience in its stores via menu upgrades and changes to workflows. This will likely help the company to preserve its market share in the face of rising challenges from the embattled casual-dining space. Unfortunately, rising marketing and personnel costs will probably make a better operating margin and higher shareholder value difficult for Panera to engineer in the short run. As such, prudent investors should watch the action in Panera from the sidelines and wait for a lower stock price to present itself prior to taking a position.

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