It’s also important to note that Panera operates in the highly fragmented and mostly mature restaurant industry, so future growth will come mostly by taking share from competitors. But while it’s somewhat true that Panera competes with the likes of Chipotle Mexican Grill, Inc. (NYSE:CMG) and other quick casual restaurants, Co-CEO Ron Shaich doesn’t see it that way. He believes that as long as consumers continue to choose Panera when it comes to soups, salads, and sandwiches, Panera will keep on winning. Panera’s excellent revenue growth, strong cash flow generation, and high returns on capital give evidence that he’s right.
Management “gets it”
Here at The Motley Fool, one of the highest compliments we can give a business’s management team is that “they get it.” I believe that Panera’s executive team, led by co-founder Shaich, certainly meets that standard. They place a focus on the customer experience first and foremost. But management also treats employees like customers because they understand that happy employees go out of their way to make customers happy.
I also like it that management continues to invest in the business, even in difficult times. Through the 2008-2009 economic crisis, management continued to build new stores, and, impressively, not only increased overall revenue but also managed to achieve same-store growth. While many other restaurants were suffering, Panera was able to not only maintain its loyal customer base but also win new fans, probably because of management’s focus on uncompromising quality.
And finally, while most of Panera’s investments pertain to opening new bakery-cafes and upgrading existing locations, management has also demonstrated the ability to buy back Panera’s stock at very attractive prices. While it’s true that there weren’t many bad times to buy back stock, since shares are up more than 400% in the past decade, management still deserves credit for pulling the trigger and returning cash to shareholders in a value-creating manner rather than wasting it on overly aggressive expansion initiatives. Their actions here boost my already high confidence in management’s capital-allocation abilities.
Risks
Panera, despite its strengths, is not invulnerable to competition. Even fast-food eateries such as McDonald’s Corporation (NYSE:MCD) have increased the amount of healthy foods offered in their restaurants to better compete with Panera’s offerings. But while these threats are not to be overlooked, I believe that Panera’s relentless focus on product quality has helped it earn a high level of trust among its customers, which should help shield it from more cost-focused competition. In addition, for many consumers, Panera’s “third place” atmosphere gives it an edge over competitors built more around speed and convenience than around ambiance. Still, I will be watching closely for any signs that Panera’s customers are beginning to defect to competitors, with metrics such as traffic and same-store sales growth helping in this regard.
Food cost inflation is another threat. If prices for commodities such as wheat and proteins rise at a faster rate than what Panera is able to pass on to its customers in the form of menu price increases, Panera’s margins will suffer. But with gross margins rising fairly steadily over the past five years, Panera has demonstrated pricing power — the ability to raise prices without drastically affecting demand for its products. But pricing power lasts only up to a certain point, and I will be monitoring gross margins vigilantly to see that Panera is able to keep its costs in check.
