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Bite Into Einstein Bagel

Posted: Aug 11, 2008 07:59 AM by Will Ashworth

Tickers in this Article: PNRA, MCD, BAGL

Whatever happened to the bagel? I love them, yet there's not a lot written about the doughy breakfast item. It's the Rodney Dangerfield of pastries, the poor cousin to the donut. That may never change but Einstein Noah Restaurant Group (Nasdaq:BAGL) is doing its best to keep the bagel front and center at the restaurant counter. Management's patience seems to be paying off.

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Things Haven't Come Easy
The company's history dates back to 1993, when it opened the New World Coffee shop in Greenwich Village. With 270 square foot, the store offered great coffee and breakfast pastries. Several acquisitions later, the company underwent a recapitalization in 2003, adding a new management team to revive the business. Since that time, it's closed 74 company-owned restaurants and 174 franchised and/or licensed stores due to under-performance. Today, it is the largest operator of bagel restaurants in the U.S. with five brands: Einstein Brothers, Noah's New York Bagels, Manhattan Bagel, Chesapeake Bagel Bakery and New World Coffee. Including the franchising and licensing, it has 639 stores in 34 states and the District of Columbia, competing in the "fast casual" space, which is situated between fast food and full-service. It hasn't been easy.

Past Red Ink
Since 1997, Einstein Noah made money twice: once in 1999, and the other in 2007. A net loss that once was as high as $73.5 million in 2003 is now in the black. Revenue from 2003 to 2007 have stayed between $380 million and $403 million with positive same-store sales growth in each of the last three fiscal years. In fact, the second quarter's 1% increase was its fifteenth consecutive period of growth. It's safe to say the company is moving in the right direction. Management's tight focus has grown operational income from a loss of $17 million in 2003 to a gain of $28.3 million in 2007. In June last year, it completed a $90 million secondary offering for five million shares. The net proceeds paid down the $65 million second lien term loan and $25 million subordinated note. This move alone cut the annual interest expense from $34 million in 2003 to $12.4 million in 2007. Three more years of net income growth and its shareholder deficit will be gone. (To learn how to easily factor corporate debt into your valuations, read Debt Reckoning.)

The Glass Is More Than Half Full
Second quarter numbers show that it's managing its growth well and not over-extending itself. Second quarter revenue grew 4.3% and income from operations 26.6%, generating $11.4 million in cash from operations. Sales were tempered in the quarter by reduced hours of operation at some restaurants, which cut same-store sales by 0.6%; and many of its locations are in California, Florida and Arizona, places hurt by the housing downturn. This cut same-store sales by another 1%.

Despite those two negatives, it was able to pull in a positive comp. On top of this, the store-level margin improvements more than made up for any lost sales from fewer operating hours. Continuing its mantra of strong operational efficiency, the company is aggressively pursuing initiatives to lock in food costs for 2009, thus lowering its expenses down the road. All of this leading to greater profit.

Growth On The Horizon
During the second quarter, Einstein Noah opened three company-owned restaurants, eight licensed locations and signed development agreements for nine future franchised outlets. That's just the beginning. In late June, Einstein made several announcements including an agreement with Aramark to open Einstein Brothers locations in its dining facilities across the country, as well as a three-store franchise development deal for Einstein Brothers locations in Tyler, Texas. The franchisees are Wilbur and Matt McKinney, experienced restaurant operators in the area. (To learn the ins and outs of life as a franchisee read, Is Buying A Franchise Wise?)

Its most important declaration was that it was rolling out the Einstein Brothers franchise opportunity nationwide due to the success of its initial plan that began in December 2006, in the Southeastern part of the U.S. It's been that well received by prospective franchisees. With nationwide expansion comes risk, but management appear to have its hands firmly on the wheel.

Bottom Line
Einstein Noah believes quick and casual dining is a $6 billion market due to baby boomers' eating habits. While it has no direct publicly traded competition, it does lock horns with industry heavyweights McDonald's (NYSE:MCD) and Panera Bread (Nasdaq:PNRA). That's definitely something to keep in mind.

Greenlight Capital, LLC owns 67.5% of the stock. Greenlight provided the cash for the recapitalization in 2003. Furthermore, directors and officers own another 4.7% of the stock. With the price down 21.7% in last 52-weeks, and profits at an all-time high, I'm confident shareholders are holding for future gains. For those who don't mind a little risk, Einstein is a stock to chew on.

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.

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