Bread and Water for Panera

Panera (Nasdaq: PNRA  ) may be a good example of a company that has a brand consumers absolutely love, and lots of growth, but a problem getting the profitability picture right -- which adds up to one thing: Investors, beware.

True, Panera's third-quarter sales increased an impressive 33%. Also true, net income for the quarter increased by 10% to $12 million, or $0.37 per share, hitting the increased guidance the company gave several weeks ago. Here's no surprise: The company described contracting margins from rising costs for ingredients and labor and a shift away from soups, salads, and self-made bread to higher-cost salads.  

The forward picture doesn't look as hot and satisfying as the company's fresh-baked bread, either. Panera gave fourth-quarter guidance for earnings of $0.53 to $0.59 per share, which is basically flat compared with last year. Ouch.

Restaurants aren't easy pickings for investors right now. Panera blamed consumer uncertainty, and many other restaurants are also struggling in this climate. Ruby Tuesday (NYSE: RT  ) recently admitted that it's lost at least 5% of its customers to rivals. P.F. Chang's China Bistro (Nasdaq: PFCB  ) has cut its guidance for 2007, too. Cosi (Nasdaq: COSI  ) has also cited rising expenses and slow traffic as dragging on its results. On the other hand, there are some winners -- take McDonald's (NYSE: MCD  ) and Chipotle (NYSE: CMG  ) (NYSE: CMG-B  ) , the high-flying concept it spun off.

It's harder to push gourmet fare when so many consumers are nervous, and rising expenses don't help. In Panera's case, though, some of the troubles are particularly its own, and not short-lived, since this has been going on for quite some time (check out last quarter). It seems to be able to drum up impressive growth, but hasn't excelled in growing profitably. My Foolish colleague David Meier took an in-depth look at this phenomenon in July.

Panera has targeted earnings growth of 10% to 20% in 2008, and said it's working on remedying the margin compression, but given the stock's drop today, investors are obviously skeptical. I don't blame them. When it comes to operating its growing stable of restaurants, investors need proof that Panera can do so with far more profitability -- without sacrificing the quality its brand is known for -- before taking a slice of these shares. 


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