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Since recommending shares of Einstein Noah Restaurant Group (Nasdaq: BAGL ) back at the end of September, the results have been tasty. The stock has appreciated more than 30%, and even more importantly, the company continues to show investors that it has put the troubled time of the recession behind it.
When I last discussed the stock, I expressed reservations about the company's balance sheet, but the company has continued to successfully deleverage and on Tuesday announced it would be reinstating a dividend with an initial 12.5-cent quarterly payout. The dividend will yield about 3.8%, which sounds like some pretty delicious dough. While this certainly sends a good signal about management's confidence in the business, let's take a look at the company's performance over the last few months, and some of the challenges it faces in 2011.
The road ahead
The biggest threat to profitability over the next year is inflation, especially in the price of wheat, which is the company's greatest input cost. Einstein management is expecting cost inflation of between 2% and 3%. Similar to one of its top competitors, Panera Bread (Nasdaq: PNRA ) , Einstein has locked in wheat prices. However, Einstein has locked in only 50% of its wheat costs for the first quarter of next year, while Panera was able to lock in 75% of its wheat for all of 2011 at prices comparable to what the company paid this year. So if Einstein CFO Manny Hilario's view on inflation holds, Panera stands to see more benefit from its wheat hedging.
While inflation could certainly affect the company's profitability, Einstein's most recent product initiatives should more than offset this. It differentiates itself from peers in the quick-service restaurant space through its healthy and fresh offerings. It is difficult for consumers to find healthy options, especially during breakfast hours, which is exactly where Einstein excels. Fast-food chains like McDonald's (NYSE: MCD ) , Burger King (NYSE: BKC ) , and Wendy's/Arby's Group (NYSE: WEN ) have been focusing heavily on breakfast, from which Einstein gets about 65% of its revenue.
Einstein launched its lower-calorie bagel-thin sandwiches this summer, and they have already grown to take nearly 4% of the total sales mix. CEO Jeff O'Neil explained that having a lower-calorie sandwich option has shifted many customers from smaller-ticket items such as a bagel and cream cheese to these more expensive sandwiches.
Einstein is also looking to bring in even more revenue through its growing coffee business. The company is testing premium roast coffee and new specialty drinks with the addition of full-service coffee bars and baristas at 40 locations. While this is not likely to scare Starbucks (Nasdaq: SBUX ) just yet, a successful rollout would only help expand Einstein's important breakfast revenue base. And the coffee could help draw people who would otherwise prefer Einstein's food to Starbucks' offerings.
Einstein also recently began to expand its healthy snacks. The company now has six breakfast and lunch snacks under 400 calories, and is drawing consumers away from competitors like Chipotle (NYSE: CMG ) , which has yet to figure out the snacking space, or the "anything low-calorie" space.
The bagel maker is not only growing its business at the store level, but also continues to see favorable trends in its catering business, a small part of the total revenue base that was able to grow by 9% during the latest quarter as new marketing initiatives and an online ordering platform were implemented.
Einstein Noah is a great way to play the growing quick-service restaurant space, and is still a much less expensive option than its closest publicly traded peer, Panera Bread. While commodity inflation will certainly be a headwind in 2011, the company is again growing profitably. In addition, it now pays to wait for additional growth as the company has reinstated a fairly sizable dividend for shareholders. Low-calorie or not, that certainly still tastes good to me.