Is It Time to Give Up on Panera Bread?

Prior to this summer, Panera Bread (PNRA) had been a market darling. This had everything to do with the company's business strategy, which was to offer high-quality food in a warm, inviting, and comfortable atmosphere. This Starbucks-like approach to bakery-cafés led to customers spending a lot of time in Panera Bread locations, which then led to consistent repeat orders. Panera Bread locations in suburban areas and strip malls didn't hurt, either. These trends are still taking place today, but perhaps not to the same extent. And while recent numbers have been good, some warning signs are in play. If you're going to invest in fast-growing specialty eateries or quick-service restaurants, then it's possible that Chipotle Mexican Grill (CMG 6.33%) and/or Starbucks (SBUX -1.02%) presents a better investment opportunity. 

Recent results
In the third quarter, comps improved 1.3%, with company-owned bakery-cafe comps increasing 1.7%, and franchise-owned bakery-cafe comps growing 0.9%. Overall, weekly net sales increased 0.5%, and diluted EPS jumped 19% to $1.48. If you look at the year-to-date numbers ending September 24, positive trends are also intact. Year-to-date comps increased 2.8%, and average weekly sales grew 2.2%.

You might be wondering what the problem is, or if one actually exists. The following quote from Panera Bread's CEO, Ron Shaich, is telling:

"We have now concluded that operational friction, including capacity and throughput constraints, along with a less differentiated experience not only limits our ability to grow transactions today but could also inhibit our ability to benefit from a number of potentially significant transaction-driving initiatives, including national advertising and enhanced access for customers, that are being readied to begin roll out in 2014."

The phrase "less differentiated experience" is the key. After other companies witnessed the success of Starbucks and Panera Bread with their approaches to atmosphere, they copied that approach. Therefore, Panera Bread is no longer unique. While the food is still of high quality, there are many other restaurants that offer high quality. Panera Bread is losing its uniqueness edge, which is probably why the company has reduced expectations.

Lowered guidance
For the fourth quarter, Panera Bread has lowered its EPS expectation to $1.91-$1.97 from $2.05-$2.11. This still represents a 9%-13% increase over Q4 2012, but lowered expectations aren't reason for optimism. Also, Q4 comps have been lowered to flat-2% growth from 3%-5%, and operating margin is expected to decline 100-150 basis points year over year.

For FY 2013, Panera Bread expects EPS of $6.77-$6.83, which represents a 15%-16% increase over FY 2012. This is a positive. However full-year comps have been lowered to 2%-2.75% from 3%-5%. And FY 2014 EPS is expected to be below the low end of the long-term growth target of 15%-20%. Chipotle Mexican Grill and Starbucks offer more reason for optimism, but one might offer more potential than the other. 

Chipotle Mexican Grill is good
Chipotle Mexican Grill uses high-quality ingredients and a unique fine-dining approach to fast food in order to drive traffic. This approach has worked, and it seems as though Chipotle Mexican Grill is what Panera Bread had been for so long in regards to growth. Panera Bread is maturing, and Chipotle Mexican Grill might still have a few more years prior to this processing taking place. 

Chipotle Mexican Grill saw revenue increase 18% in its third quarter, with comps growing a very healthy 6.2%. EPS increased 17.2% to $2.66. And if you look at the first nine months of the year, comps improved 4.2%, with EPS improving 16.6% to $7.93. Chipotle Mexican Grill also expects full-year comps to grow in the mid-single digits. 

Starbucks is great
Starbucks, despite its long history of growth, is on fire. In the fourth quarter, EPS increased 37% to $0.63, with revenue improving 13% to $3.8 billion. Comps grew 7% overall, with 8% improvements in the Americas and China/Asia-Pacific, respectively. Margins expanded in all segments, and operating margin expanded to a record-high 17.6%. Starbucks also increased its quarterly dividend 24%, based on strong performance and optimism about future results.

Looking ahead, Starbucks expects FY 2014 revenue growth of at least 10%, with comps in the mid-single digits. Operating margin is expected to expand 150-200 basis points, and EPS should come in between $2.55 and $2.65. Additionally, Starbucks plans on opening 1,500 new stores, which will drive the top line.

Key metric comparisons
Let's see how these companies stack up fundamentally:

Starbucks offers the highest profit margin and return on equity while also paying a dividend. In other words, its the best at turning revenue and investor dollars into profits, and you're going to be paid via dividends regardless of how the stock performs. While all three companies are fundamentally sound, Starbucks is the most impressive.  

The bottom line
Panera Bread is a good company, but with its growth likely to slow in the coming years due to a less differentiated customer experience, it might be a difficult transition for management. While a bounce back to new 52-week highs is possible, an investment in Chipotle Mexican Grill or Starbucks gives investors higher odds of success. This is especially the case for Starbucks, which offers continuous top and bottom-line growth, strong guidance, and pays a decent yield.