The following commentary was originally sent to Action Alerts PLUS subscribers on Dec. 21, 2015, at 6:42 p.m. ET.
Heading into the New Year, we believe Panera Bread (PNRA) is poised to outperform its restaurant peers, and for that reason is one of our top picks for 2016. Although the stock has rallied from its recent lows in the middle of November (due largely to better sentiment in the segment and market share potential from Chipotle's E.coli outbreak), we think 2016 holds multiple levers of growth that could propel this name to new highs. (Panera Bread is part of TheStreet's Action Alerts PLUS portfolio.)
As we have mentioned in the past, the key driver for PNRA in the New Year will be the continued execution of its Panera 2.0 initiative, which is aimed at utilizing cutting-edge technology to bring a quick, efficient and enjoyable experience to customers who visit the restaurant. The company is roughly one-quarter through the conversion process, so while there is some uncertainty around the continued implementation of the plan, management has indicated that the vast majority of company-owned restaurants will be converted by the end of 2016, and the data thus far have shown same-store-sales lifts from the Panera 2.0 models.
Importantly, this signifies management's confidence in the initiative as it implies they will continue the 100-plus store conversion pace quarter over quarter in 2016. That being said, we believe earnings guidance has been on the conservative end as management ramps up the process, but the benefits from the newly revamped stores should come sooner rather than later, leading to upside surprises in sales, followed by a rally (or rallies) in the stock.
While the startup costs, of course, will remain high as the conversion process moves along, we believe many investors are aware of this, which is one of the reasons why the stock has yet to break out. Even better, high cost comps figures will get easier as we head into next year and the company anniversaries a large number of store conversions from the second half of this year. As the stores become normalized to the Panera 2.0 model, labor costs also benefit from the higher digital sales mix (as these higher check orders -- potentially 20% to 25% higher -- leverage fixed costs).
Further into the future, management believes a more prevalent digital business will also undoubtedly help drive small-order delivery and catering orders, which adds supplementary markets for the company to expand upon (catering sales have already showed explosive growth, up 12% in the fiscal third quarter). According to leadership, company comps performed almost 200 basis points better than franchisees in the latest quarter, largely due to sales initiatives that have yet to be released to franchise owners (such as 2.0, marketing focus and delivery hubs to bolster catering). If this is any sign for things to come, and we think it is, the company will only perform better as these pilots are distributed throughout its entire ecosystem.
Lastly, Panera has been a leader in the transparent food sourcing movement, which has been driven by the consumer's desire not only for nutritious offerings, but also by the need to know where food is coming from and what exactly makes up the ingredients. As consumers continue to become more conscious of their food -- from a health, sanitation and sourcing perspective -- PNRA is poised to benefit given its long legacy with transparent and reliable food sourcing, combined with growing brand equity from new marketing campaigns focused on this new trend (as can be seen in the company's most recent "Should Be" commercial campaigns).
All in, two continuous years of EPS declines have kept the name at bay, but we believe management will guide to EPS growth for fiscal 2016 (the company releases its fiscal 4Q results on Feb. 9) as it realizes the benefits from the past two years of focused improvements. Adding to the story is the remaining tranche of the planned $500 million of share repurchases (expected to be completed in the fiscal first quarter) and the additional $250 million of incremental repurchase authorization outstanding (albeit with no confirmed time frame).
In the end, we think 2016 sets up as a beat-and-raise year for the company, which will ultimately justify multiple expansion as investors jump in to get a piece of the pie.
