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Pencils Fund Purchase: Panera Bread

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By pencils2
January 9, 2007

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Pencils Fund Purchase: Panera Bread (PNRA)
Purchase Date: 1/8/07
Purchase Price: $55.75
Shares Purchased: 3
Commission: $6.95

Business

Panera Bread engages in the ownership and franchising of bakery-caf�s in the U.S. Panera offers baked goods and other dough items, pizza, soups, salads, custom-roasted coffees, a lot of natural, fresh, organic food. Panera really aims for a great customer experience, and because of this, they offer free WiFi in most of their bakery-caf�s. Panera has a line of dipping oil, dipping sauce, dressings, and whole bean coffee "for your pantry" as well. Panera also operates bakery-caf�s under the Saint Louis Bread Co. name. Panera was founded in 1981 and currently operates more than 1000 bakery-caf�s in 38 states.

Financials

Market Cap                           1.77B 
Enterprise Value                     1.70B 
Shares Outstanding                   31.63M 
Float                                30.09M  
Employ­ees                            5,100  
Qtrly Rev Growth (yoy)               37.90% 
Qtrly Earnings Growth (yoy)          -6.80%  
Revenue (ttm)                        769.39M 
Gross Margin (ttm)                   35.42% 
EBITDA (ttm)                         131.65M 
Oper Margins (ttm)                   11.06%  
Net Income (ttm)                     56.10M 
EPS (ttm)                            1.754
P/E (ttm)                            31.78 
P/S (ttm)                            2.30 
Total Cash (mrq)                     72.02M  
Total Debt (mrq)                     0 


Panera is aiming to open one bakery-caf� every other day, and with that strong balance sheet, I certainly like the chances of that happening. You might feel that a P/E around 31 is high for a company with such a foundation as Panera, but Panera still has tremendous opportunity in the U.S. and possibly even internationally. Plus, the average P/E for the industry is 31.9, so Panera doesn't look a bit overvalued to me right now. It is priced a little bit at a premium, but because of their growth opportunity and how they've executed in the past, the stock deserves it.

Panera's business has been strongly producing cash flow and has never been reliant on the bank in recent memory, even with a fast rate of expansion. The latest quarter saw the business produce $22.32 million. I love companies that can expand without gaining debt and without relying on something other than the business to finance that growth. Panera is such a company. I can't get over Panera's balance sheet, it almost gets me drooling like their food does. The balance sheet hasn't had a smack of debt since fiscal 2001. Since that time, and this period has been the heaviest expansion time, the cash position has more than tripled. If Panera can expand at such a fast rate without gaining debt, relying on the bank, and tripling their cash position, I believe this company has something going for it.

Panera has an experienced management team. Ronald Shaich, chairman and CEO, has been with the company since 1988, and has done a fantastic job running and expanding the company while keeping the food quality. Shaich, directly and including indirectly (possibly through a spouse or other family member) owns a total of 154,920 shares, making him the largest insider holder. Insiders together hold a total of 1.51 million shares. I hope Panera can keep this management team for a long time, because they've done a great job of expanding the business without hurting the balance sheet a bit.

The key for Panera's expansion is their bakery-caf�s, obviously. Panera will definitely be a company who's helped by a rising organics crowd, which is currently growing at 15%-20% and still makes up only 2% of the whole U.S. food market. Panera has a niche for sure, and that niche will greatly benefit from a larger natural, organic, healthy crowd, which I believe will continue to keep growing. Starbucks recently announced that they are aiming to get 20,000 caf�s up and running in the U.S. Now, Panera doesn't quite have the ability of Starbucks to have a caf� every other block, but they can do some close expansion, more so than other restaurants. I think Panera could have one of their caf�s every 15-20 miles from another one, because people go out of their way to get to Panera, just as they do to get to Starbucks. Panera has a great reputation, so as long as they have that, expansion will come relatively easily. What I'm getting at is if Starbucks believes they can operate 20,000 Starbucks, then I believe Panera could easily operate 4000-5000 bakery-caf�s. Remember that they are opening a bakery-caf� every other day right now and that they are still in only 38 states. With the balance sheet in great shape and the business strongly producing, I certainly see Panera being able to take advantage of opportunities when they come along.

Panera recently released info on the 4Q 2006 sales, and I think they're impressive. Total retail sales grew 25% from $183 million in last year's 4Q to $233 million today. Panera lowered earnings guidance in December because of the Midwest storms and outages, where 40% of the company's bakery-caf�s are located. For the year, Panera expects earnings between $1.87 and $1.90 per share, down from previous guidance of $1.92 or $1.93. This is still a great jump over fiscal 2005's EPS of $1.65, so I'm not concerned about this at all. The long-term prospects are still there and intact, and the company has the resources and management to take full advantage of those prospects and opportunities.

Risks / What To Look For

-- Expansion - If Panera does expand too quickly or too close together, it would mean problems. If these problems, or any other problems for that matter, did come up, Panera could handle some of it with the strong balance sheet. I believe management is smart and knows what locations/areas where Panera would do well. But, this will be something to keep an eye on.

-- Competition - Competition from other eateries and caf�s will be something that could hurt Panera. Again, I believe management is smart and knows what tactics work in this area, but competition is still a factor that could hurt Panera and something to follow.

-- Location - As I mentioned above, 40% of Panera's bakery-caf�s are located in the Midwest. If a significant amount of these locations suffered serious damage for whatever reason, it'd hurt the company. Again, the strong balance sheet means the company can handle some difficulties. But if anything major kept the caf�s shut or the customers away, Panera wouldn't have much support from the stock market.

Valuation

Analysts expect Panera to grow earnings at 24.5% annually for the next years. I believe that is very possible with the rate they are opening caf�s and the room for margins to expand, but I'll assume we see some other short-term problems come up that take their share away from earnings. I'm expecting earnings growth of 18% annually for the next five years with a P/E of 27. Current EPS is 1.754.

1.754 * (1.18^5) * 27 = 108.34

That'd make a 14.5% annualized return from here on out, not too shabby. For my high estimate, let's go with the analysts' 24.5% expectation with a P/E of 30.

1.754 * (1.245^5) * 30 = 157.40

My low estimate will be 15% earnings growth with a P/E of 23:

1.754 * (1.15^5) * 23 = 81.14

I will hold onto this investment for a long, long time, simply because Panera still has a huge opportunity here in the U.S. and internationally. I will be holding for a long time.

Conclusion

Panera was out of the favor with the market in 2006, which has pushed the stock down from in the $60s to even the $40s during the summer sell-off. I would be glad to invest more and more into Panera if the market keeps providing such opportunities, because Panera has a great product, great and experienced management, a strong balance sheet, a business that produces strongly and fuels its own growth, and most important, Panera has a lot of potential left in it. I'm in.

Best,

David K


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