An In-Depth Overview of Panera Bread

Originally published on December 22, 2014, by Adam Jones, this overview of Panera was substantively updated on December 23, 2019, by Rajiv Nanjapla.

Panera Bread (formerly PNRA) is a limited-service restaurant company that operates fast-casual restaurants. It serves fresh-baked goods, soups, sandwiches, pasta dishes, salads, and custom roasted coffee. It also offers catering services.

Panera has 2,181 restaurants. Most of its locations are in the US, but it has a few in Canada. In total, it has more than 100,000 employees.

The company operates restaurants under three brands: Panera Bread, Saint Louis Bread Co., and Paradise Bakery & Café. It operates these brands under the same fast-casual format. In July 2017, JAB completed its acquisition of Panera Bread in a $7.5 billion deal and took the restaurant company private.

Fast-casual restaurants combine the fast-food concept—prime examples being McDonald’s (MCD) and Popeye’s—with the casual-dining concept—prime examples being Olive Garden and Chili’s. Olive Garden operates under the Darden (DRI) umbrella, and Chili’s operates under Brinker International (EAT). Some of these restaurants are part of the SPDR S&P 500 ETF (SPY).

Panera uses operated and franchised business models, unlike Chipotle Mexican Grill (CMG), which doesn’t franchise its restaurants. To learn more about fast-casual and other restaurant formats, read The state of fast-food restaurants and Two more concepts: Pizza places and cafés.

Let’s take a look at Panera’s financial performance, value drivers, competition, and unit growth ahead of its acquisition in order to better understand it. We’ll start with its revenue growth.

Panera Bread reported revenue growth at a CAGR (compound annual growth rate) of 12.9% from 2006 to 2016. But as we can see in the graph above, the company’s revenue growth was below its CAGR in the few years before it went private. It reported revenue rises of 6.0% in 2015 and 10.5% in 2016. In the first quarter of 2017, its YoY (year-over-year) revenue growth stood at 6.2%.

From 2006 to 2016, Panera’s peers Chipotle Mexican Grill and McDonald’s reported CAGRs of 16.8% and 1.3%, respectively. McDonald’s strategic decision to refranchise led to lower revenue growth. In the restaurant industry, the fast-casual restaurant concept was poised to grow. Shake Shack (SHAK), a recent entrant in the fast-casual space, has seen tremendous growth in the last five years. It went public in January 2015 at an IPO price of $21. As of December 18, 2019, it was trading at $60.49.

Panera reported its revenue in the following three segments:

1. Bakery-Café Operations.
2. Franchise Operations.
3. Fresh Dough and Other Product Operations.

Bakery-Café Operations

Bakery-Café Operations are Panera’s café operations. Panera is in charge of all these operations. It also keeps all of the associated revenue. This segment accounts for most of Panera’s revenue. In 2016, the segment generated revenue of $2.43 billion, a rise of 3.2% from $2.36 billion in 2015. SSSG (same-store sales growth) of 4.2% largely drove this revenue growth. Compared to 2015, the company increased its number of bakery-café units by one in 2016.

Franchise Operations

At the end of 2016, Panera had 1,134 franchised restaurants. Through royalties and fees, the segment earned revenue of $155.3 million, a YoY rise of 12.1%. This growth was driven by the addition of 63 franchised restaurants and SSSG of 0.7%. Since the company doesn’t have many costs associated with its Franchise Operations, the segment’s operating margins are high.

Fresh Dough

Panera distributes ingredients, such as fresh dough, tuna, produce, cream cheese, and proprietary sweet goods, to its company-owned cafés. It also delivers ingredients to its franchised restaurants. According to Panera, items are delivered at cost, which doesn’t exceed 27% of the end product’s retail value.

At the end of 2016, Panera had 22 fresh dough manufacturing facilities covering 20,000 square feet. Twenty were company-owned facilities, and two were franchise-owned facilities. The segment generated revenue of $206.1 million in 2016, a rise of 11.9% from $184.2 million in 2015. Positive SSSG and the addition of new restaurants led the segment’s revenue to rise.

Similar operations

Other restaurants have similar operations. Domino’s Pizza (DPZ) operated 18 dough facilities in the US and five dough manufacturing facilities in Canada at the end of 2016. Dunkin’ Brands (DNKN) has similar operations. It delivers ice cream products to its Baskin-Robbins stores.

Some restaurants also get their products from food distributors such as US Foods. US Foods purchases products from other producers. For example, it purchases meat from Tyson Foods (TSN). It then processes the meat and distributes it to other restaurants.

What drives these segments’ revenues?

These segments’ revenues depend on restaurant-level sales. If Panera’s restaurants are flourishing, they’ll require more ingredients. Eventually, the Fresh Dough segment will benefit. To determine the performances of the company’s restaurants, we need to consider Panera’s same-store sales and what drives them.

To understand what drives revenue, we need to look at the most important value driver: same-store sales. Investors watch same-store sales to check on the health of their investments in restaurants and retail stocks, such as Nike and Gap.

Most of the company’s activities include, but aren’t limited to, the following:

1. Reinventing its menu.
2. Remodeling stores.
3. Enhancing the customer experience through Panera 2.0 and delivery initiatives.
4. Loyalty and reward cards.
5. Advertising.
6. Marketing.

The company’s activities revolve around its efforts to entice more customers to walk through its doors. More customers mean more sales!

SSSG’s correlation with revenue

The chart above compares Panera Bread’s SSSG with its revenue growth. The correlation between its same-store sales and revenue growth is 0.51. We can see that Panera’s same-store sales came in below 3% from the beginning of 2012 until 2016. In response, management rolled out Panera 2.0 to enhance the customer experience at its restaurants.

Panera 2.0 includes digital ordering, fast pickup, and the utilization of technology to improve operational efficiencies. By the end of 2016, 70% of Panera’s company-owned restaurants were remodeled according to its Panera 2.0 strategy.

Why Panera’s same-store sales failed to impress

In 2016, Panera Bread reported system-wide SSSG of 2.4%. Its company-owned restaurants reported SSSG of 4.2%, and its franchised restaurants reported SSSG of 0.7%. Meanwhile, McDonald’s reported SSSG of 10.5% in the US market during the period, while Shake Shack posted SSSG of 4.2%. Chipotle Mexican Grill’s SSSG fell 20.4% in the period due to its food-safety issues.

Same-store sales indicate a restaurant’s ability to generate revenue. They include tickets and traffic. Tickets include two more factors: price and mix.

Tickets

In the chart above, we can see that tickets had a more pronounced impact on Panera’s same-store sales than traffic. A ticket is the amount a customer spends per transaction at a restaurant. In 2016, Panera’s average ticket size increased by 4.1%. The increase in its menu prices contributed 2.3% to its average ticket growth, while a favorable mix drove the remaining 1.8%. Mix means the growth in the number of items ordered per transaction.

A company has the flexibility to change its product mix. It can entice customers to purchase additional items—such as a package of chips or a soda—if they’re ordering a single item. This increases the overall amount the customer ends up paying per order.

However, it doesn’t have as much flexibility on prices. If prices increase too much, it could cause customers to go to a competitor instead. In this way, the greater contribution from favorable pricing to SSSG wasn’t a healthy sign for Panera.

Traffic

In the chart above, you can see that Panera’s traffic had a weaker impact on its same-store sales than tickets. Traffic means the number of customers that come and eat at a restaurant. Several factors drive traffic, but advertising and promotions are big influences. These factors clearly weren’t working in Panera’s favor in 2016.

In 2016, Panera Bread spent $71.6 million, or 2.6% of its total revenue, on advertising. This advertising included contributions from franchisees. In 2016, its franchise-operated restaurants contributed 2.6% of their sales to national advertising funding and 0.4% to marketing administration fees. Also, franchisees had to spend 0.8% of their sales on marketing in their respective markets. The company’s ad spending increased in 2016 compared to $68.5 million in 2015 and $65.5 million in 2014.

In 2016, Chipotle Mexican Grill spent 5.1% of its revenue on advertising and marketing expenses, which was significantly higher than 2.1% in 2015. In an effort to win back its customers after a series of food-related issues, Chipotle hiked its marketing spending. During the same period, McDonald’s spent $645.8 million, or 2.6% of its revenue, on marketing.

In 2016, Panera Bread ran its MyPanera customer loyalty program, which allowed the company to better engage with its customers. It stated that 51% of the transactions at its restaurants were associated with the loyalty program by the end of the year.

Replacing its advertising agency

In September 2014, Panera Bread selected Anomaly as its lead creative agency, replacing Cramer-Krasselt. The company launched its marketing campaign, “Food As It Should Be,” in 2015. More recently, in September 2019, the company launched its new “Few have reached our level” spots to gain leadership in the category.

Chipotle has long been actively spreading its message about its sustainable meat source, which seems to be working for it. To learn more about the company’s sustainable meat source, read An Investor’s Guide to Chipotle and Its Customers. In 2014, Panera jumped on the bandwagon and formalized its food policy.

Reinventing the message

On June 3, 2014, Panera’s management issued its food policy. Here were the key highlights:

• Panera purchased poultry and livestock that had been fed a vegetarian-based diet. It purchased fish caught in the wild.
• Its animals weren’t fed antibiotics.
• It removed artificial items from its food. These items included artificial trans fats, MSG, sweeteners, and artificial colors, flavors, and preservatives.
• It baked fresh bread at its fresh dough facilities every day. The bread didn’t contain any artificial preservatives.
• It was the first national restaurant to disclose a comprehensive food policy.

On June 17, 2014, Panera issued another memo, which provided an update on its food policy. The update included the following information:

• 91% of Panera’s pork supply hadn’t been fed antibiotics in 2014.
• 80% of its beef supply was grass fed.
• 18% of the company’s eggs came from cage-free hens.
• 100% of its chicken supply hadn’t been fed antibiotics.

It’s important to note that laws in the US don’t permit feeding growth hormones to chickens. Let’s look at Panera’s expenses.

Panera’s company-owned restaurant expenses are separated into four categories.

Food costs

In 2016, Panera spent $709.3 million on food and paper products, which represented 29.1% of its revenue from company-operated restaurants. As the name suggests, these costs include food ingredients and paper products. The paper products are used to pack the food. A company doesn’t have much flexibility when it comes to these costs. Compared to 2015, its food costs fell from 30.3% of its company-operated restaurant revenue.

Labor costs

Labor costs were the highest for Panera’s company-operated Bakery Café. At the end of 2016, labor costs made up 32.5% of its related sales, or $790.4 million. The company doesn’t have to pay the labor costs at its franchise restaurants—franchise owners do. Labor costs as a percentage of sales have also increased over the years. Wage inflation and labor-supporting initiatives caused Panera’s labor expenses to rise in 2016.

Occupancy costs

Occupancy expenses are the costs related to the restaurant property, including rent and property taxes. Panera’s occupancy costs fell to 6.9% of sales from its company-owned restaurants in 2016 compared to 7.2% in 2015. They were also at their lowest level since 2013.

Other costs

Other costs included marketing and maintenance costs. In the graph above, we can see there was an increase in the company’s other operating costs. In 2016, its other operating expenses stood at $359.6 million, 14.8% of company-operated sales compared to 14.2% in 2015. Losses from disposals and impairments led to an increase in the company’s other operating costs.

We’ve seen the four key costs related to Panera Bread’s Bakery Café operations, or its company-owned restaurants. The company also had costs associated with its other two segments—its Fresh Dough and Franchise Operations. Let’s see how each of these segments achieved operating leverage.

Fresh Dough costs

The Fresh Dough segment’s costs include the cost of sales related to fresh dough and other ingredients company-owned and franchise restaurants require. In 2016, these costs came to $178.6 million, or 7.3% of the company’s total revenue. These costs reflected an increase from 6.8% in 2015. In 2016, the company opened 45 franchised restaurants and refranchised 27 company-operated restaurants. This refranchising could have led to an increase in its dough and other costs as a percentage of its total revenue.

G&A expenses

In 2016, Panera incurred G&A (general and administrative) expenses of $179.9 million, or 7.4% of total revenue. As we can see in the chart above, these costs increased as a percentage of sales. An increase in incentive-based compensation, increased expenses to support the company’s strategic initiatives, and higher legal expenses hiked the company’s G&A expenses.

D&A expenses

Given its increasing units and fresh dough manufacturing facilities—over 22 (company-owned manufacturing facilities) as of 2016—Panera’s D&A (depreciation and amortization) was expected to rise. In 2016, its D&A expenses totaled $154.4 million, or 5.5% of its total sales compared to 5.0% in 2015. The company’s management blamed the increase in its D&A expenses on its investment in company-owned restaurants and technology to support its growth initiatives.

Considering all of these costs, let’s discuss Panera’s operating income and margin performance.

When we analyze profitability, we need to look at the trend in a company’s operating income, which means its remaining profits after operating costs. These are its profits before interest and taxes.

Falling revenue growth dented Panera’s operating income

In the chart above, we can see that the company’s operating income declined from 2014 to 2016. Its total expenses increased at a higher rate than its revenue, which caused its profitability to fall. In 2016, the company’s revenue increased by 4.2%, while its total expenses rose by 4.7%, lowering its profitable income.

In 2016, the company’s operating margin contracted to 8.6% from 9.0% in 2015. As we can see in the graph above, it declined from a peak of 13.3% in 2012. Its weak SSSG and the higher rate of increase in its expenses dented its operating margins in the previous four years.

Net income

Net income indicates the profits a company makes after deducting operating expenses, interest, and income tax expenses. In 2016, Panera earned $145.2 million, which represented a net margin of 5.2%.

In the graph above, we can see that Panera’s net profit and net margin increased from 2009 to their peaks in 2013. After that, both the company’s net profit and net margin fell. Higher interest expenses and a decline in operating profits lowered the company’s net margin in 2016. However, its income tax fell to 36.7% in the year from 36.9% in 2015.

In 2016, the company’s diluted EPS stood at $6.18, representing an increase of 6.7% from $5.79 in 2015. The growth in its EPS was the result of share repurchases. In 2016, the company repurchased 1.82 million shares for $371.2 million, implying an average share price of $204.46.

In 2015 and 2016, Panera reported revenue growths that were lower than its CAGR of 12.9% from 2006 to 2016. Along with its weaker SSSG, declines in its new restaurant additions and refranchising caused lower revenue growth for it in these two years.

By the end of the first quarter of 2017, the company operated 2,042 Panera restaurants. Of these restaurants, 1,132 were franchised restaurants, and 910 were company-operated restaurants. In the same period, McDonald’s and Chipotle Mexican Grill operated 36,905 and 2,291 restaurants, respectively. Therefore, Panera has a huge scope for expansion. Let’s look at how the company has expanded its business.

When a restaurant reaches maturity at its existing location—which means its revenue is growing at a stable, low-single-digit rate—a company can supplement its revenue growth by adding more units in newer markets or locations. A company needs capital to add company-owned units.

Panera Bread refranchised 75 company-owned restaurants in 2015 and 27 company-owned restaurants in 2016. The refranchising led the unit count of its company-owned restaurants to fall from 925 in 2014 to 902 in 2016. However, during the same period, the unit count of its franchised restaurants increased by 189 units to 1,134 units. So, the company focused on franchising to expand its business.

Correlation

From 2006 to 2016, the correlation between the company’s revenue growth and unit growth was 0.52. Correlation strength can be determined by how close this number is to one. The lower the number, the weaker the correlation. The company’s refranchising in 2015 and 2016 lowered the correlation between its revenue growth and unit growth.

Adding more units

In 2016, Panera increased its unit count by 64, including 63 franchised restaurants and one company-owned restaurant. During the period, the company opened 48 new restaurants, closed 20 underperforming restaurants, and refranchised 27 company-owned restaurants. It also opened 45 franchised restaurants while closing nine.

Meanwhile, Chipotle Mexican Grill added 225 units in 2017, while McDonald’s increased its unit count by 438 units.

Panera Bread needs capital to grow its restaurant units. Capital can be generated internally or sourced externally. Let’s look at how Panera is generating funds for its expenses.

Panera Bread’s capex included expenses from its opening of new company-owned restaurants, remodeling of existing restaurants, and purchasing of restaurants from franchisees. The company also used capital to develop, remodel, and maintain its fresh dough manufacturing facilities. It also fulfilled other developmental requirements, such as IT and infrastructure.

At the end of the first quarter of 2017, Panera Bread had cash and cash equivalents of $153.4 million compared to $105.5 million at the end of 2016. The increase in its cash and cash equivalents resulted from long-term borrowing of $99.5 million and $75.8 million worth of cash from its first-quarter operations. However, it used some of its cash for share repurchases, capex, and the repayment of long-term loans. By the end of the first quarter of 2017, the company’s long-term debt stood at $461.5 million. Meanwhile, Chipotle Mexican Grill and Potbelly used internal capital only to grow their units.

Now, let’s look at Panera’s stock performance before it was acquired by JAB.

Panera Bread delivered an impressive return of 470.5% from January 1, 2009, to July 17, 2017, when it ceased trading after JAB acquired it. Meanwhile, peers Chipotle Mexican Grill, McDonald’s, and Yum! Brands saw returns of $4,446.5, $2,486.5, and $2,925.8, respectively, in the period. In this same period, an investment in the S&P 500 Index would have returned $2,205.3.

In the graph above, we can see that there was a bump in Panera stock on April 5, 2017, when JAB announced its intent to acquire Panera for $315 per share. The offer price was 20.3% higher than Panera’s March 31 closing price.