Stephanie Link: Pondering a Piece of PNRA
It was ahead of the company's 4Q earnings report and although I'd like to take credit for saying to buy it ahead of the print, I didn't. My positive position really was more longer term, not quarter-specific, as the company fixes many of the 2013 issues, restructures and focuses more on customer service in 2014. Simply put, the risk/reward headed into 2014 is favorable, especially since the company has begun to take aggressive actions to reignite sales and growth throughout the company. The bad news is out, the expectations are low and this is one of the best management teams in the business.
Last year was challenging for Panera, with a deceleration in same-store sales, earnings, margins and unit growth. As a result, it lagged the restaurant group by 25% for the year. Not many were worse. Yum! Brands (YUM) and McDonald's take the credit there, with YUM underperforming by 30% and MCD by 40%. We own and like YUM in Action Alerts PLUS, Jim Cramer's Charitable Trust, but my eyes are also on Panera as well.
The questions for investors are whether Panera's problems are cyclical or secular, whether they are service-oriented issues or competitive and market-share loss issues. I think it's more cyclical and believe the aggressive restructuring efforts that the management has put in place will lead to better transaction growth and a recovery in top- and bottom-line results in the second half of 2014 and into 2015. They are investing heavily in technology, adding labor hours and the mobile initiatives are in very early innings. Even despite its problems, unit growth is still poised to grow 6.5% to 7% for the full year, even in this macro-challenging environment.
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When the company posted earnings earlier this week, management also lowered guidance, which I think is now a kitchen-sink type of guide. This CEO and management team understand the Wall Street game of underpromising and overdelivering and I think the assumptions are pretty conservative, especially since 2013 is not a distant memory for them. As a result of aggressive investments being made to improve the operational aspects at the company, margins will be hit more than expected and with them earnings. For 2014, the company is expecting year-over-year growth in earnings of 5% to 8% to the $6.80 to $7.05-a-share range and operating margins to fall 75-125 bps, which includes a full-year's impact of additional labor investments, improvements to customer access, operation fixes and new centralized enterprise systems.
Management plans to improve the customer experience on every front: order, payment, execution and experience. Additionally they have new menu items/innovation costs and will increase their marketing push with ad spending at 1.9% of total sales from 2013's 1.7% rate and the 1.4% seen in 2012. There was no mention of same-store sales expectations for the year, other than they are expected to improve as the year progresses. These initiatives rolled out in the fourth quarter and will peak in the first half of 2014. Interestingly, in the fourth quarter comps did see an improvement in October at 1.7% and November at 7%, but lost ground in December, declining 3.7%, with much of that tied to the polar vortex situation. The company estimated that the full-quarter weather hit was 50-70 bps to comps or roughly 3 to 4 cents a share and as a partial offset, it did see better results in speed of service, throughput and order accuracy.
On the menu side, the company has plans to roll out a new flatbreads line and has a new menu initiative that will group the items by price point with more flexibility, with the customer having options in buying what's on the menu or making their own adjustments. Having a less-rigid structure, fewer lines and more organizational efforts should improve the customer experience, and we should see the improvements pretty quickly.
With the details of the restructuring known and the guidance lowered to more realistic levels, the bad news is out of the way and the company can focus on execution. If we get more normal weather that will help as well. Sentiment is very downbeat right now and, certainly, management is in a show-me situation. But as we progress throughout 2014, we see a gradual lift to sales as these initiatives take hold and in 2015 a real earnings snapback is possible, from easy comparisons, lower investment spending and a return to more normal top-line growth.
The company will hold its first analyst day since 2006 on March 25 and I see that as a potential positive catalyst as we'll get more relevant information about how the turn is progressing in terms of production capacity, operational flow and speed of service, as well as traffic and transaction trends. The stock is not cheap on an absolute basis at 20x forward estimates, but is down from the 24x historical average and following this difficult year, I expect to see an earnings recovery back to the 15-20% level.
This is not an overnight fix by any means, but it's a proven management team, has a strong brand name and competitive positioning and is in the process of fixing the issues at hand. The next few quarters will likely be choppy, especially since the weather is also a headwind. But I like the long-term story and on a pullback to the low $170s, I like the stock.
--Written by Stephanie Link in New York.
Action Alerts PLUS, which Link co-manages as a charitable trust, is long YUM.