The restaurant business has evolved quickly in recent years, and Panera Bread (NASDAQ:PNRA) has been at the forefront of the new trend toward customers wanting quick fare that's still healthy. Coming into Tuesday afternoon's second-quarter financial report, Panera investors seemed content with the fast-casual chain's long-term strategic plan, having sent the stock to all-time highs despite expecting further weakness in sales and earnings during the quarter. Panera's results were fairly disappointing in comparison to what most investors had expected to see, but that didn't stop the stock from shooting upward to new record levels following the announcement. Let's take a closer look at Panera Bread and why investors are rewarding what seem to be lukewarm results at best.
Panera Bread: hot stock, cold performance?
Panera's second-quarter results looked a lot like the disappointing performance we've seen from the company for a while. Sales climbed more than 7% to $676.7 million, but investors had hoped to see $679 million in revenue. Even worse, net income as reported dropped by 15% to $41.9 million, and even after taking into account some extra expenses connected to refranchising efforts, adjusted earnings of $1.61 per share were down 7% from last year's second-quarter results and missed expectations by $0.02 per share.
One slight sign of life for Panera came from accelerating comparable-restaurant sales. During the second quarter, Panera posted comps of 1.8%, which while relatively low were still more than a full percentage point higher than in the first quarter. Company-owned restaurants continued to outperform, with sales climbing 2.4% while franchise-operated locations saw comps gains of 1.1%. A nearly even distribution of higher customer counts and average check sizes contributed to the results.
Still, as we've seen in past quarters, operating expenses held back earnings and hurt Panera's margin levels. A drop of 1.5 percentage points in operating margins came from the costs of Panera's strategic efforts as well as higher costs of labor, and the reductions in overhead expenses were insufficient to offset the rising costs elsewhere. Food costs and paper-product expenses also contributed to the drain on operating earnings.
Panera has nevertheless accelerated the pace of its expansion plans, opening 18 new company-owned locations and allowing franchisees to open a dozen more. Newer franchise locations have continued to outperform company-owned stores, with about a $4,700 advantage in average weekly sales for the quarter.
Panera CEO Ron Shaich continued to tout the company's long-term progress, arguing that "our strategic plan to generate increased shareholder value by making Panera a better competitive alternative with expanded growth opportunities is making a difference." Shaich pointed to early results in the third quarter as bolstering the bullish argument for the stock, and he also believes that "initiatives to expand into several billion-dollar-plus adjacent businesses, including catering, delivery, and [consumer-packaged goods], are generating powerful sales growth and show increasing promise."
Can Panera 2.0 succeed?
Those early indications give Panera investors some cause for hope. During the first month or so of the quarter, comparable-restaurant sales growth climbed to 4.7%, and Shaich's comments suggest that those favorable trends could continue. Given how long investors have waited for confirmation that Panera's strategic plan would eventually lead to accelerating growth in sales, even a small sample of positive results must seem attractive.
The disconnect, though, is that at least in the short run, Panera 2.0 doesn't seem to be improving the company's key results. Panera said once again that comps will finish the year up 2% to 3.5%, and earnings per share could be at best flat and worst down as much as high-single digit percentages. A decline of between 1 and 1.75 percentage points of operating margin will also weigh on results for the rest of the year.
The big question is whether the huge investment that Panera is making in its future will pay off. The company will open a total of 105 to 115 new cafes this year, and it's looking to convert 300 locations to the Panera 2.0 framework by year-end. As Shaich explained, the extensive costs of those conversions and new delivery hubs will hurt near-term profit growth, but as he said, "In our history, sales have led and profits have followed, and we believe that will again be the case at Panera."
Long-term Panera investors apparently agree, helping to send the stock soaring by more than 8% to new all-time highs in the first 45 minutes of after-hours trading following the announcement. Given the optimism that shareholders have for the stock right now, it's clear that Panera Bread will have to live up to huge expectations in the long run. If its initiatives eventually bring the results that Panera investors demand, then this afternoon's share-price gains will make a lot more sense.
Dan Caplinger 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.