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Panera Bread Battles Rising Wheat Prices

Posted: Jul 07, 2008 15:33 PM by Gregory S. Davis

Tickers in this Article: PNRA, SBUX, BAGL

Who needs a home office when you can get breakfast, lunch and access to the internet at Panera Bread (Nasdaq:PNRA)? Starbucks (Nasdaq:SBUX) is calling for store closures while Panera is finding success with its mixture of panini, soups and baked goods.

If you've ever stopped in for a snack on your lunch break, you likely weren't standing in line by yourself. The company's locations are consistently busy. However, with all that bread to bake, rising wheat prices can't be good for business. Let's have a look at how the company is faring.

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First Quarter
Panera stock is up more than 30% since the beginning of the year while the S&P 500 is down about 14%. At the end of the first quarter of 2008, Panera had 1,252 bakery-cafes in 40

U.S.

states and revenue exceeded $1 billion. Revenue has been increasing each year since 2003, but commodities prices have added additional expenses that pushed operating profits downward in 2007.

Commodity Commotion
The commodities boom and higher demands for food have dramatically increased prices of agricultural good. Panera's cost for wheat jumped 140% in 2007. To mitigate ongoing expenses Panera used futures contracts to lock in wheat prices in 2008. Panera does pass on a portion of the additional expense for wheat to its franchisees.

Even with the futures contracts in place, Panera's cost of wheat more than doubled for the first quarter of 2008 to $13 per bushel. Higher wheat costs along with higher labor and occupancy expenses caused operating profits to drop nearly 11% despite a 27% increase in revenue over the same period a year ago. (To learn more about wheat futures, read Grow Your Finances In The Grain Markets.)

Competition
Panera has a price-to-earnings-growth (PEG) ratio of 1.20. Value investors look for PEG ratios below or near 1 as an indication of an undervalued stock.

Competitors with lower PEG ratios include Starbucks at 1.05 and Einstein Noah Restaurant (Nasdaq:BAGL) at 0.7. Panera reported an operating margin of 7.82% on revenue of $1.13 billion last year. Meanwhile, Starbucks reported a slightly higher operating margin of 8.85% on $10 billion in revenue.

Conclusion
Panera has the right concept in place with a strong customer base. The company has worked hard to attract customer who could just as easily stop at numerous competitor locations for a bite to eat and an internet connection. If Panera can get a handle on its wheat costs, investors could be rewarded for investing in a business that has become a favorite meeting spot for many.

Put your money where your mouth is: read Sinking Your Teeth Into Restaurant Stocks.

By Gregory S. Davis

Gregory S. Davis is an investment writer and consultant for his company G.Davis Capital Inc. His core methodology for choosing investments include patience, diversification and asset due diligence. Gregory is a graduate of the Wharton School of Business. He is also a board member of StoriesWork, a non-profit organization based in Durham, NC that uses storytelling to empower youth and individuals to utilize alternative dispute resolution tactics.

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