Waiting On Panera Bread

In last Friday’s article on Panera Bread, I wrote, “I think Panera looks good at recent prices.” I do, but I realized later that phrasing it that way made it seem like I was buying already.

I’m not.

As is my way, I’ll watch Panera for a while to see if we can shave another 16% off the price to buy at $35 or so. In this weakening market environment — which Kelly Letter subscribers saw coming all the way back in late April and stood prepared with a healthy list of stocks to watch with target buy prices — the sale affects all companies indiscriminately. The good and the bad go down, so waiting to buy looks smart.

About Panera being a good company with a stock worth waiting to buy, frequent site contributor Dave Van Knapp of Sensible Stock Investing wrote:

Your article on Panera got me interested enough to “score” the stock according to the framework that I use.

Points you mentioned and my interpretation:

  • I agree that Panera is not threatened by McDonalds. They serve different markets. But Panera does face competition in the “casual dining” or “comfortable dining” segment. The few times I’ve gone there, I would not rate them as highly as some of their competitors for that level or type of dining experience. I’ve been disappointed (so has my wife). Panera’s “Story” would score 6 (out of 10) in my book.
  • Panera’s valuation is what I would call “Fair+.” That makes it a good — not great — buy at its current price. I look at several valuation ratios, and when I blend them together, I get “Fair+.”
  • Stair-step increasing earnings are something I always like to see.
  • Decreasing revenue growth rate. Actually, according to Morningstar, their 3-year rate is 32% and their past 12 months is 30%. I don’t see significant fall-off there. I don’t think that’s why the market has been dropping Panera’s multiples.
  • Their valuation multiples (looking at several measures) grew fairly steadily from 1997 to 2004 or 2005, then have declined steadily since then. I don’t see anything that’s going to cause them to reverse and start going back up, although at some time I expect they will hold at fairly steady levels. Right now, I don’t think the market has sorted it out yet…what’s the right multiple for Panera?

Points not mentioned by you and their significance:

  • No debt…I love to see that.
  • No dividend…don’t like that, although it’s understandable for a growing company.
  • ROE of 14 and falling for the past three years. Not a good sign. I give extra credit for ROE > 15, and still more credit for keeping it above 15 for several years running. They’re going in the wrong direction.
  • EPS growth rate has been falling. Their 3-year rate is 23%, while their past year was 12%. I suspect that’s more responsible for their stock price’s difficulty than any other single factor. Related: Their EPS growth rates are lower than their revenue growth rates. That’s not a good sign; it suggests problems in controlling costs somewhere along the line.
  • PEG ratio of 0.9 is terrific.
  • I don’t like the fact that their stock price has been falling. It’s a pattern I’ve seen with many growth companies: Their valuation and stock price grow until EPS growth slows or reverses, then valuation and stock price both go backwards until the company finds some sort of steady-state “mature” level. So beyond a good valuation, I like to buy a stock when its price is going up. I like my purchases to get off to a good start, so I almost never buy in the face of a declining price.

As you can see, my approach has a lot of fundamental similarities to yours, but I also try to get the best of both worlds by using some simple technical factors. It’s basically the same question I asked about Apple and the idea of shorting it: “What’s it doing?” Panera is falling, for reasons that seem typical of the way the market often interprets fundamentals, in this case ROE and EPS growth both trending downwards.

So for me, this stock would stay on a watch list, but I wouldn’t buy it now despite its good story and better-than-average valuation. As you advocate, wait and watch.

As always, a good run-down by Dave. One place where he and I differ is in the spot of the recovery where we target a buy. He goes for a chart that has already turned up after bottoming, in hopes of getting on the elevator as it’s heading up.

I, however, don’t mind buying along the flat line that is the bottom, and even averaging down from there if I believe strongly enough in the company. Because most people invest on a regular basis rather than in lump sums all at once, a stock that flat lines or fluctuates in a range that forms a band representing the bottom provides investors with a longer time period during which they can put money to work in the good idea they found.

My favorite example of this was way back in June, July, August, and September of 1993 when IBM was the hated has-been of the computer industry. It was my first big discovery in the stock business. Everybody said I was a fool to chase yesterday’s story and didn’t I know that “you don’t get fired for owning IBM” was a phrase from the 1970s, not the 1990s?

Ignoring that, I began pulling capital from every possible place I could free it up and putting more into IBM shares every week. It wasn’t easy, as the headlines around the company were awful, with talk about breaking it into several component parts and selling it off. Imagine buying into that story.

A four-month time frame that happened 14 years ago may seem like a blip of scariness that anybody could have seen through. In the middle of such retrospective blips, however, they don’t seem so insignificant. The latest market downturn around tightening credit and sub-prime implosions, for instance, is barely three weeks old but people are discussing it as if it’s been dragging on for years. Forecast the tone if this atmosphere persists until the end of November. Pretty dreary.

So it was with IBM back in summer 1993 as the weeks wore on, the news darkened, people lost their jobs, and a cartoon appeared showing nerds standing around loaves of bread on a table sporting a sign that read “Bake Sale” in the IBM logo’s horizontal striped font style. Pretty dreary.

As you can see on the chart, IBM’s price fluctuated in a band between about $10.25 and $11.75 (split-adjusted) for four months before finally breaking out under the stewardship of Louis V. Gerstner, Jr., who later wrote Who Says Elephants Can’t Dance? about his turning Big Blue around. Money put to work weekly during those rough four months was the very picture of Bill Miller’s strategy slogan: “Lowest average cost wins.”

Shares of IBM rose steadily over the next six years. They split two-for-one in 1997 and again in 1999, and peaked at $139 in July 1999, some 1,165% higher than they sold for during summer of 1993 when the future was supposedly so dismal for the company.

Long periods of stuck stock prices for companies you believe in — and can prove with good research to be solid prospects — are heaven.

You won’t hear them discussed much on financial TV shows or in fast-paced trading newsletters that miss out on such long-run winners when they sell at the first little peak, but that’s where the stock market’s truly big money awaits. All these crummy trading services do so many p
eople a disservice with their “three stocks you need to know about for tomorrow” and forget about the next day. All you really need is one or two big ideas a year, and the guts to stick with them, to watch your money grow.

Back to Panera.

Is now the time to buy? Dave could well be right that there’s further downside ahead, and I’m not buying yet, so waiting looks to be the official word around here. That said, I’m confident that anybody who bought last week at around $40 will be looking back one day not so far from now and smiling at how well they’ve done.

While all of my experiences at Panera have been positive, Dave mentioned that he and his wife were disappointed by Panera as compared to some of its competitors, although he didn’t name those competitors.

Bruce Becker reported similar disappointments in greater detail:

We no longer go to Panera, and the same applies for a number of our neighbors. The franchisee lost the store in the neighborhood. He financially mismanaged a number of franchises he held and took them all down. They had a great manager who recognized her customers and catered to them. The coffee was good, as were the bakery, sandwiches, and soup. They opened a new place just across the highway — totally mismanaged, constant turnover, coffee like colored water, cream cheese in sample dish floating in ice water with no sample but crumbs (they don’t know enough to clean up for the sake of appearance), etc. Speaking to the manager did no good as somebody new was always there. It’s a company store.

After a long absence, a friend wanted to have lunch with us about 10 days ago and suggested Panera. We said OK and said maybe things had changed. What did we find? Colored water coffee, dried sharp cheddar on the sandwich (took it back to the counter and they found me a piece that was a little less than bad). My only regret was I didn’t short the stock. This shop is located in Superior, Colorado. They will have to go a long way before I buy their stock or their food.

What about you? Any firsthand Panera experiences to report? Send them to me, please.

We haven’t heard the last on this stock yet. One reader wrote that his college roommate was Neal Yanofsky, president of Panera Bread, and that he’s “a truly brilliant guy.” I asked the reader if he could arrange an email interview for me, and am waiting to hear back.

Coming Soon: Customer responses to Power Investor President Frank Lardino, Blockbuster vs. Netflix, Pfizer, and the state of U.S. health care.

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