After years of rapid revenue and earnings growth, Panera Bread Company (NASDAQ:PNRA.DL) is officially in reinvestment mode. Revenue is beginning to moderate from competitive pressures, and margins have been affected by both cost input inflation and resources the company is pouring into long-term strategic objectives:
During PNRA's most recent conference call, management discussed its growth initiatives in detail. The following are notable quotes regarding the company's current set of goals, along with other topics the executive team wants investors to be aware of.
"2.0" will have a major impact, but don't expect it overnight
Panera 2.0 clearly drives sales. Cafés converted to Panera 2.0 are consistently among the top-performing bakery-cafés in Panera in terms of comp store sales growth [...] However, I must caution that it's too early to be able to say definitively what the ultimate medium- and long-term sales impact will be from Panera 2.0. -- CEO Ronald Shaich
"Panera 2.0" is the name given to Panera's technology-driven, "version 2" of itself. The initiative marries digital ordering and payment with more advanced kitchen software to speed up orders for customers. In one scenario to be common at Panera locations in the future, customers can order ahead, pay for, and pick up a packaged meal from their local cafe's shelves, avoiding the line entirely. In another scenario, those who order ahead will be seated and receive table service once they arrive.
"Panera 2.0" is projected to be implemented in a total of 100 restaurants by year-end. That's roughly 5% of PNRA's 1845 systemwide locations. The company is incorporating learning curve lessons in real time and hasn't committed to the number of 2.0 conversions it will achieve in 2015.
While management foresees the long-term benefit of improving its software systems, digital / mobile capabilities, and total customer experience, it's quick to point out that the resources required to institute such changes will produce a near-term drag on earnings.
The expansion of 2.0 is currently averaging costs of $20,000 to $30,000 per store. While this will drive up income statement expenses initially, management believes margins will eventually benefit from the rise in digital orders, which provides an offset to labor cost.
In our future: the $1 billion-plus side business
This is approximately a $300 million business for Panera. And it accounts for roughly 8% of our total annual sales. It's more than just a side feature of our retail business. It's a real business unto itself, and it requires intense focus and attention to fulfill its potential. -- CEO Ronald Shaich
Increasingly, Panera views its cafes as a base from which it can launch new businesses. Take Panera's blossoming catering business, which it likes to call "Large-Order Delivery." The company envisions Large-Order Delivery as a possible billion-dollar segment, and is reconfiguring its current catering model by opening preparation and delivery hubs in a small number of cities. Panera has rolled out 9 delivery hubs in the last five business quarters (through September 30th). But the company intends to ramp up this number significantly in Q4, with a stated goal during the conference call of having 16 additional hubs opened by year-end.
CEO Ronald Shaich opined that as Large-Order Delivery scales up, it will alleviate pressure on the cafes, while also providing future opportunities for small check (home and office) delivery. Shareholders can expect Large-Order Delivery to make up significantly more than the current 8% of total company revenue in the coming years.
Why we're spending on technology
Looked at in its totality, technology is not just a line on the P&L to be managed. It's a vital part of structural enhancements that we believe will provide our customers a better and a truly differentiated experience here at Panera. -- CEO Ronald Shaich
One theme running through much of the October 29th conference call was the importance of spending on software and technology for initiatives like Panera 2.0 and Large-Order delivery, but also to capitalize on opportunities for revenue and margin enhancement.
The company has taken out $100 million in long-term debt in 2014 to help finance its growing technology spend. The executive team believes spending money on systems and software today enhances return on invested capital down the road. So for Panera, growth is not simply about capital investment in more restaurants, it's about capital investment in smarter restaurants, which enhances the company's value.
Unholy cow: butter and dairy will hit our margins
To give you a sense of the scale of the issue, dairy and butter make up roughly 15% of our total input costs. On a full-year basis, we now expect butter and dairy to increase by over $7 million. -- Interim CFO William Moreton
If it surprises or astounds you to learn that 15% of Panera's food input costs are comprised of butter and other dairy products -- well, it's a bakery cafe, after all! Milk futures in the U.S. have been on a tear in 2014, clocking 11 consecutive months of price increases.
There may be some relief for Panera next year: According to the USDA, 2014's projected dairy price increase of 3%-4% will moderate somewhat to 2.5%-3.5% in 2015. But this is only a projection, and recent dairy price trends have been unusually strong. The bottom line: The potential of diary to squeeze Panera's operating margin is real, and it's possible we haven't heard the last of this operating pressure from management.
We know we've lost some mind share to the competition
The only way to build sustainable transaction growth is by being a better competitive alternative. That means customers must be willing to walk past competitors to reach Panera. -- CEO Ronald Shaich
While Panera executives didn't name names, one of the competitors Panera has in mind is Chipotle Mexican Grill (NYSE:CMG), which seems to have captured both popular and investor interest from Panera Bread. While Chipotle's food offering is quite different from Panera's, the two restaurants are competing for the same customer: middle- and lower-income fast-casual patrons.
Long-term shareholders should like the intent behind the quote above. Realizing that its target patrons have to choose Panera's food versus competitors' indicates that the company is aware of and attacking the competitive advantages its peers hold.
To illustrate, one of the primary topics of any Chipotle earnings conference call is the Mexican chain's enviable throughput, an execution point that has allowed it to grow so quickly. Increasingly, improving throughput is also top of mind for Panera's management. CEO Shaich disclosed that one of the company's primary focus areas, throughput at its peak hour (weekday lunch between noon and 1 p.m.), improved 4% versus the prior year this quarter.
It's a much more complex world in the fast-casual restaurant space as we head into 2015. In bygone years, it seems Panera's management team only had to worry about the pace of new restaurant openings. But the focus on becoming a permanent "better competitive alternative" is a means by which the company can create value for quite some time to come.
Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Panera Bread. The Motley Fool owns shares of Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.