Panera’s New Growth Avenues Poised To Become More Meaning Cash Flow Contributors

Technomic recently released its annual 2017 Top 500 Chain Restaurant Report, which examines the top players in the chain restaurant industry and ranks those restaurants by sales. Unsurprisingly, the results of the annual ranking show that fast casual continues to be a powerhouse — the segment grew sales 8% in 2016. Leading the pack was Panera Bread, which inched out Sonic Drive-In for the number 11 spot.

One of the biggest reasons to consider Panera is its low debt/equity ratio, which is around the same range as Buffalo Wild Wings (BWLD). With the general economic climate over the past couple of years, this value for the debt/equity ratio makes Panera particularly attractive.

Success of Panera 2.0

With Panera 2.0, there has been a focus on changes in consumer behavior around order, payment, production and consumption to help “bend the arc” on traffic trends. So it must be said that the ultimate goal of improving guest experience in order to build Panera’s competitive position has been achieved. Panera has become a better competitive alternative and expanded growth opportunities. Costs have become more manageable as sales have ramped up, with both labor and other controllable expenses falling as a percent of sales. Panera 2.0 customer experience investments have reinforced the brand intangible asset underpinning my positive moat trend.

There was a lot of transparency with the 2.0 market rollout allowing investors to read the results and make their own determination as to success of the initiative.

Downside Factor: P/E ratio is rather high

When it comes to fundamental ratios, the P/E is very valuable. As an investor, the best strategy is to pick the stock with the lower P/E. Right now, the P/E for Panera stands at 47.57 which is on the high side. Generally, this is acceptable in the fast casual and sports bar industry. But it makes for a tough scenario for investors when deciding whether to buy the stock or not. Additionally, there is the P/B ratio which is not acceptable at a value of 25.11.

At the same time, the big thing to love about BWLD is the return on assets currently and over the past five years. It suggests that its relatively high operating returns are sustainable.

Strong Balance Sheet Is The Plus Factor

The one noteworthy thing about Panera is that there is less debt in the balance sheet. This is a particular favorable time to be investing in companies with lower debt levels as money is hard to come by this year. The company can look to formulate a solid growth strategy that doesn't reek of desperation when it has less debt to deal with. At a time when most people and companies are drowning in debt, the best strategy is to move away from excessive debt levels and leverage. Panera gives an investor this opportunity. As mentioned earlier in this piece, the low debt/equity ratio is indicative of a strong balance sheet.

Global Economic Spectrum: People Always Have Money For Food

There are two main issues that are impacting the world right now. One is the issue with total global debt which continues to grow at a rather swift pace. The other predicament has been the rise in oil prices. The problem with high debt levels is that given an economic slowdown, a jump in interest rates or some other financial shock, business and household borrowers won’t be able to service their debts. As a consequence, consumption dips. High oil prices also have this effect on consumption. But there is always one thing that can sell like hotcakes and that is fast food.

Valuation

I believe Panera can ultimately deliver long-term EPS growth in the mid teens, likely at the lower end of their prior long-term guidance for 15-20%. With that said, the timeframe over which this will once again be achieved on a consistent basis is uncertain (acknowledged by management). And such is only accentuated as investors contemplate Panera’s move from growth to maturity, coupled with plans to begin refranchising efforts, pushing franchises north of the prior 50/50 split. While there is a lack of near-term EPS growth visibility, I believe the shares will once again sustain a multiple near the upper end of the recent ranges, in anticipation of improved fundamental performance, with an expected return to double-digit EPS growth in 2018, and accelerating further in 2019.

Risks

Competition, specifically related to price, service, locations and food quality, is the most significant risk faced by companies in the restaurant industry. If there was a significant change in the competitive landscape from current levels, the valuation would have to be reconsidered. Other risks that would require me to review this investment thesis include food safety, including the effects of food borne illness, changes in governmental regulations surrounding the restaurant industry and fluctuations in interest rates and commodity prices.