By Warren Gump (TMF Gump)
June 13, 2000

Trading at $9 11/16 as of June 9, 2000

This year's selection for Dad is an upscale bakery/cafe chain that is emerging as a true industry leader through the expansion of franchise and company operations. The Panera Bread Co. (Nasdaq: PNRA) name may not yet be familiar to everyone, but that will likely change over the next few years as the number of stores explodes.

Panera Bread stock has been on my radar screen for several years, many of which have been painful. The company's stores still go by Saint Louis Bread Company, its original moniker, in its home market. When I was a college student in St. Louis, three Saint Louis Bread Company stores were within walking distance. Beyond offering fresh bread, topnotch sandwiches, and lots-o-pastries, "The Bread Co." offered a relaxing place to escape from campus life. The company was privately held at that time, but it caught my eye as an alluring investment idea.

In late 1993, Au Bon Pain purchased the Saint Louis Bread chain. Due to my love of the Bread Co., I leapt at the chance to put a few dollars into Au Bon Pain. Oh, Dad, if only I had listened to your advice to do due diligence on any investment. While the Bread Co. generally continued to perform well, it was only a small part of Au Bon Pain's operations. The challenges faced by the Au Bon Pain chain, compounded by a hefty corporate debt load, caused Au Bon Pain's stock to fall from over $20 per share at the end of 1993 to less than $10 at the end of 1995. Over the next four years, the stock gyrated between $5 and $10 per share. I sold those shares at a loss several years ago, but continued to watch what happened.

Some good news finally emerged last year. After determining that the Panera Bread concept offered more enticing growth than Au Bon Pain, the company announced the divestiture of its namesake chain. This sale enabled the renamed Panera Bread Co. to pay off all its outstanding debt, in addition to focusing the company on only one concept.

The sale of Au Bon Pain closed a little over a year ago and the strength of the Panera Bread concept is starting to show. In the company's recently released first quarter earnings release, Panera Bread posted a profit of $0.12 per share, up 140% over pro-forma prior-period results.

Company revenue increased 37% during the period and systemwide sales, which include the results of franchised units, jumped 83%. Importantly, same-store sales continue to be strong, with an 8.9% increase -- the 17th consecutive quarter of improvement.

A large part of Panera's growth is coming from increased franchise operations. At the end of the first quarter, the franchised store count had increased to 116 units, up 50 locations over the prior year. This growth is important because it allows the company to quickly raise brand awareness with nominal capital outlay, while increasing franchise royalties. During the first quarter, this high-margin income stream increased to $2.4 million from $1.0 million. The strong results of Panera Bread units opened during the past year, where annualized sales are running 10% higher than the company-wide average, give credence to franchisee plans to develop another 525 units.

Panera is also expanding the number of company-owned stores. Thirteen new company units are expected this year, 16% growth from the 81 units open at the beginning of the year. These units allow Panera to participate in the attractive unit economics of the concept, while also proving to franchisees that the company believes its concept is a great investment.

The sale of Au Bon Pain dramatically improved Panera's balance sheet. The company got rid of all its debt so that it could start over with a clean slate. While the company has taken on about $3 million in debt to fund the growth of company units and new commissaries, it will likely avoid high debt levels given the problems incurred at Au Bon Pain. The desire to maintain only modest debt helps explain why the company isn't ramping up company unit expansion to a faster pace. Current capital expenditure plans for the year total $16-$17 million, a majority of which should be funded from operating cash flow.

Panera stated that it believes it can achieve 74% earnings per share growth this year (to $0.40), followed by 30% or more annual growth thereafter. If the first-year results for the standalone Panera are indicative of the future, these objectives seem attainable.

Next: PepsiCo »

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