No. of Recommendations: 4
Hi B,

Sorry for the late response.

Panera came in below Wall Street’s estimates for sales ($589 million vs. $596m expected) and EPS ($1.74 per share vs. $1.77 expected) due mainly to lower-than-expected same store sales growth at its restaurants.

They also took down their guidance for Q3 and Q4 and for the full year, stating that they now expect full year comp store sales to come in between 3% to 5% (down from 4% to 5%) and full year EPS growth of roughly 15% to 16% (down from previous guidance of 17% to 19% EPS growth ).

Panera’s management realizes that they have a throughput problem, saying this in the conference call:

The real governor on our transaction growth has been throughput limits in many of our stores on many days. In fact, we have come to believe that both our production capacity limitation and our own labor expectations serve to dampen our ability to grow lunch transactions.

And they are taking action to correct it:

As previously noted, it has become clear to us that we are limiting our sales growth potential, particularly at high-peak hours and particularly at lunch. What we do know is that our production times are up 32 seconds greater in quarter 2 of 2013 than in quarter 2 of 2012. We know that in order to consistently operate at the very high sales volumes we're generating and to benefit from the additional sales building initiatives we're developing, we must improve our peak hour throughput and operational capabilities. A number of actions are already underway to address this issue. Let me review with you those initiatives now.

First, we are reviewing and expanding physical capacity, which we believe may be a barrier in some cafes. Second, we will be rolling out new production processes and new production communication tools, including a new kitchen display system, which are designed to improve throughput and accuracy at high volume. Third, we're looking at opportunities to reduce complexity in our production system and in our cafes. Fourth, we're refocusing our teams on the right metrics and on disciplined processes. Fifth, we will judiciously add labor with discipline where appropriate. And sixth, we're working hard to evolve our enterprise systems to enable our managers to focus on value creation in the cafes rather than administrative tasks. Understand that many of these initiatives cannot be executed in short order, but they will happen as quickly as we can make them happen and trust they will ultimately lead to even higher sales.

The good news is that they do not believe it’s a demand issue. To the contrary, management is afraid to pull all of their growth levers at the current time because they’re worried that they won’t be able to handle all the traffic that the promotions, television marketing, and MyPanera loyalty initiatives would create. So they’re investing in strengthening their ability to increase throughput first, and when they feel they’re ready, they’ll pull more of their growth levers.

Co-CEO Ronald M. Shaich had this to say on the call:

We’re very excited about a number of sales drivers that we have in place. We think the opportunities to take these volumes significantly higher are very, very real. And we're talking in significant terms, particularly as we think about some of the initiatives we've signed up to take on this year, that we indicated to you earlier and in prior conference calls, that we're spending money on. Some of it's increasing access to Panera initiatives, national advertising. And we know we will end up in a boom splat situation if we don't increase the throughput and capabilities. Our constraint to sales growth isn't the ideas, it isn't the customer demand, they're there. It's actually our capabilities of fulfilling it and executing it.

And CFO Roger C. Matthews said this:

The next 4 quarters will be a time in which we prepare to drive sales through increased access to Panera, national marketing and a full utilization of our loyalty program. We will simultaneously improve our operational capabilities and increase cafe throughput in order to effectively meet the demand we intend to fuel. While these results in the next few quarters may be more lumpy as we invest in these efforts, we believe that they will ultimately enable us to deliver an enhanced customer experience, grow sales and expand earnings.

Those investments are going to increase labor costs and some other operating expenses, which is part of the reason for the lowered EPS guidance. The fact that they’re holding back some of their advertising is likely a reason for the lowered revenue guidance, along with the slowing same-store sales numbers they’ve been seeing in recent months.

But management believes that they know how to fix the problem and are taking action to do so. I have confidence that Ron Shaich and his team will improve restaurant operations to the point where they can effectively handle the higher traffic numbers that these growth initiatives will bring, and I’m excited to see what the sales numbers look like when Panera goes full throttle on growth, or at the very least, eases up on the brakes.

That’s because Panera’s brand and concept is still very much resonating with consumers. We can see that in the new restaurant sales numbers:

Our development activities and strong new unit average weekly sales demonstrate that consumer demand for Panera is resonating in a powerful way with our customers as we more deeply penetrate the markets in which we operate. The returns we are generating from new unit cafes continue to be very strong, with our new unit return on investment targets generally at 20% and internal rate of returns that are higher than that.

During the second quarter, we opened 37 new bakery-cafes systemwide, 18 company and 19 franchised. We now believe that we will be at or above the high end of our original 2013 new unit opening target of 115 to 125 units. We continue to be very pleased with the productivity of these new units. New company-owned bakery-cafes had average weekly sales of $50,983 year-to-date versus $48,484 last year. This, again, puts us on pace for another record year.

… These strong new unit sales confirm the extraordinary appeal of our concept and our continued ability to identify strong new store locations as we more deeply penetrate our existing markets. Our new franchise bakery-cafes have also performed at record pace, with average weekly sales of $49,855 year-to-date, compared to $47,109 year-to-date -- last year. This level of franchisee growth and sales performance is evidence of our franchisees' continued confidence in our concept and a willingness their invest their capital in new stores.

So I believe the long-term growth thesis for Panera remains very much intact. The company continues to innovate and has several mouthwatering new menu items that will be rolled out later this year. Its advertising campaign, "Live Consciously. Eat Deliciously," has been well received by consumers and Panera believes it will see an even more favorable impact on traffic when it mixes in some food-specific communication to go along with what has been a mostly brand building campaign to date. The MyPanera Program now has over 14.5 million members -- up from 11 million members this time last year -- and Panera’s management believes that number will continue to grow substantially and that the program provides robust data that will allow it to better understand its customers and more effectively target promotions. And finally, Panera doubled its sales per cafe and profit per cafe over the last decade – a steady trend of improvement that I don’t think will end so suddenly. That’s because Shaich and his team have demonstrated time and again the ability to adjust their strategies as needed to deliver an excellent customer experience. And while these next few quarters may be volatile, I expect them to right the ship and put Panera back on a path to enviable same-store sales growth and expectation-topping profitability in the years ahead. As such, Panera remains Tier 1.

Joe T
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