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					                           Panera Bread Company
                                Mr. Dave Sluga
                               Mr. Dan Oleyourryk

Company: Panera Bread Company (PNRA)
Recommendation: Buy
Purchase Price: $33.50
Current Price: $39.99
Number of Shares: 5%
Target Price: $41.93
Bailout Price: $30.00
Reevaluate at: $41.93
Company Analysis

Panera Bread Company is a small cap stock that sells on the NASDAQ with the ticker symbol of
PNRA. Panera Bread Company operates in the retail bakery-café segment of the restaurant
industry in the services sector. Under the control of CEO Ronald Shaich, Panera Bread
Company functions under the names of Panera Bread Company and St. Louis Bread Company.
Originally, Panera operated primarily only on the east coast but has now opened up operations in
35 states. Panera’s stores are located mostly in suburban areas near malls and other shopping
centers. Panera Bread offers an assortment of breads, deli sandwiches, salads, and pastries
among other products. Panera competes in the restaurant industry against such restaurants as
McDonald’s and Wendy’s, but Panera’s differentiation from its competitors comes from its café
environment including a more up-scale and healthy menu (see menu).

Panera Bread Company began as Au Bon Pain Company in 1981 operating on the east coast. In
1993 Au Bon Pain Company purchased St. Louis Bread Company, which was comprised of 20
bakery-cafes in the St. Louis area. From the years 1993 to 1997, the bakery-cafe names changed
to Panera Bread. In 1999, Au Bon Pain Company sold all business units except for Panera and
the company was renamed Panera Bread Company. Since the companies restructuring Panera
Bread Company has become one of Business Week’s “100 Hot Growth Companies.”

Panera Bread Company has recognized large scale growth in recent quarters and is now on pace
for large growth rates in the future. Panera currently has 429 franchise operated stores and 173
company-owned bakery-cafes. Panera’s ability to increase sales of franchises has enabled
Panera to grow rapidly. Panera does not sell single-unit franchises but rather sells franchise
agreements of generally 15 stores in 6 years. Panera has strict criteria that must be met to buy a
franchise including a certain amount of capital that is required. Panera depends on increased
sales of franchises and increased revenues in same store sales to continue at its large growth rate.
Panera Bread Company is a small cap company with great growth potential as their name
becomes more widely known.

News and Current Events

The fast food restaurants have been hit hard by the recent health craze that has struck the United
States. This consumer trend has benefited Panera significantly because Panera offers what most
consumers believe to be a higher quality product at a slightly higher cost. McDonald’s and
Burger King are attempting to cater to the health conscious consumer by creating more health
efficient products. However, companies such as Panera Bread and Wendy’s Baja Fresh have a
leg up on the competition. On the negative side, now that most fast food restaurants have seen
the consumer trend for healthier food, competition has grown. Fast food chains are altering their
menus to stay current with the needs of the consumers, which will increase competition for
Panera Bread.
On November 11, Panera Bread Company announced that sales have increased 5.1% for the
month of October. Both company-owned and franchised bakery-cafes were successful in
                                   October 30, 2004
Company-owned Sales Increase                                        3.4%
Franchised Sales Increase                                           5.8%
Total System Sales Increase                                         5.1%

This is a promising report to Panera investors in that it shows that both segments of operations
were able to generate increased sales in October. The increase in franchised bakery-cafes is
particularly significant because franchisees pay royalties and add to the advertising pool on a
percentage of sales basis. Panera Bread believes that the figures are indications of how well
Panera can do in the future.

On December 2, 2004 Panera Bread announced that its Chief Operating Officer and Executive
Vice President, Paul Twohig, has resigned. Twohig has served in these two roles for Panera
Bread since January 2003. No stated explanation has yet been given for Twohig’s resignation.
Panera Bread will use four of its Senior Vice Presidents to fill Twohig’s two roles in the
organization. JP Morgan has stated that this resignation will result in a neutral change in Panera
Bread’s stock price, which initially fell $.34 following the news but is steadily recovering.

Industry Analysis

Panera Bread Company operates in the very competitive restaurant industry. Panera is known as
a casual fast food restaurant, which means that they are a fast food provider but produce a higher
quality product and offers a unique dining environment. The fast food restaurant industry is
extremely competitive. Panera Bread competes against all the large fast food companies such as
McDonald’s, Burger King, and Wendy’s as well as cafes such as Starbucks and New World
Restaurant Group Inc. Panera Bread Company is one of the younger companies in the industry,
which means that room for growth is still abundant. McDonald’s has now moved into global
markets and is focusing much of its marketing in those markets. Panera Bread differentiates
itself from the normal fast food chain by offering a bakery and deli style sandwiches. Panera has
found a distinctive niche in the restaurant industry enabling it to market to a growing costumer
pool that wants better quality food.


McDonald’s is the largest fast food chain in the world. They have been very successful in
expanding into international markets. McDonald’s CEO, Charlie Bell, recently stepped down
due to health concerns, which resulted in a price fall in their stock. However, since the naming
of Jim Skinner as CEO, analysts have reaffirmed a positive outlook on McDonald’s. The
success of Panera Bread and other such places has forced McDonald’s to reassess their menu and
add healthier items. McDonald’s also markets to a different market than Panera Bread in that
McDonald’s is a low cost provider. Panera Bread stays in suburban areas while McDonald’s has
a suburban presence but also floods the cities. So although McDonald’s and Panera Bread do not
operate too similarly, they do compete in the same industry and it is important to look at
McDonald’s as a main competitor when analyzing the restaurant industry.

Starbucks Corporation has a very similar niche to that of Panera Bread Company. However,
Starbucks concentrates only on the beverage side of the café. Panera Bread also sells coffees and
cappuccinos as Starbucks does, but Panera has a wider variety of products to sell. Starbucks and
Panera are considered to be competitors because they both have a café environment. Starbucks
has been extremely profitable in years past. Both companies take advantage of the unique
environment that a café provides.

New World Group Inc. owns and operates several different companies entitled Einstein Bros.,
Noah's, Manhattan, Chesapeake, and New World Coffee. New World Group sells café
beverages, bagels, soups, salads, and deserts among other products. New World Group’s cafes
may be the most direct competition to Panera Bread. New World Group is a much smaller
organization than Panera Bread but both produce similar products and target a similar customer

A major risk facing Panera Bread is the high level of competition that exists in their industry.
The restaurant industry is rather saturated especially in the fast food segment. McDonald’s,
Burger King, and Wendy’s are a few of the fast food chains that already have a strong reputation
in the industry. It may be difficult for Panera Bread to gain market share in some markets
because of the strong presence and name recognition of these and other fast food restaurants.
Panera Bread must continue to differentiate itself from these fast food juggernauts through
product quality and dining environment.

Panera Bread has specific criteria that must be met for a person to open a franchise. Included the
entrepreneur must open up 15 franchises in 6 years and have a net worth of $7.5 million while
having qualified skills in the restaurant and real estate industry. Panera Bread depends upon
franchises for much of their growth and strict guidelines may prohibit some potential franchisees
from being formed. However, rapid growth expansion may also lead to quality control problems
concerning locations and products.

Panera Bread is a relatively new player in the restaurant industry. It was not until 1999 that they
made an impact in the industry and investors began to realize their potential. Panera’s historical
data shows their turnaround in growth and the impact it has had on their stock price. Panera
Bread’s stock price has steadily been increasing at an impressive rate. The assumptions used in
the free cash flow analysis are based on historical statistics as well as growth projections in the
future. Panera Bread still has much room to expand in the restaurant industry and has shown
much indication that they plan to do just that. Panera Bread does not currently pay dividends, so
the free cash flow analysis and market comparable analysis are the best measurements to find
Panera Bread’s intrinsic value.

Free Cash Flow Analysis

Panera Bread Company does not have any debt so their cost of equity and weighted average cost
of capital percentages are the same. This resulted in Panera Bread’s free cash flow to equity
intrinsic value and free cash flow to the firm intrinsic value to be the same amount. The cost of
equity figure is particularly low and is very close to the sustainable free cash flow growth rate.
This results in large price variations if either figure is altered even slightly.

Panera Bread plans on increasing growth by increasing same store sales and opening more stores
through franchises. Panera Bread’s growth rate in bakery-café sales is 20% in the first year, 15%
in the second year, and 10% in the following years. In 2003 their bakery-café sales grew 25%
and Panera Bread is again in line for future growth. Panera Bread’s franchise royalties and fees
are estimated to grow 25% in the first year, 20% in the second year, and 15% in the following
years. These growth rates are in line with past data and with predicted increases in franchises.
Fresh dough sales to franchises is the most rapidly growing segment of revenues at 35% in year
one, 30% in year two, and 25% in each of the following three years. These segmented growth
rates yield total revenue growth of 23% in 2004, 18% in 2005, 13% in 2006, and 14% in 2007
and 2008. These growth rates are relatively conservative estimates compared to historical data
and analyst estimates. The costs and expenses were forecasted as a percentage of sales based on
historical data other than depreciation and amortization, which is projected as a percentage of
property and equipment based on the forecasted balance sheet. The growth in property and
equipment (capital expenditures) of 16% is based on future growth opportunities. The growth
rate in net working capital of 12% is an estimated number based on future growth in franchises.
The most sensitive estimate is the sustainable free cash flow growth, which changes the price
significantly as seen in the sensitivity analysis. The free cash flow growth rate of 8% is a
projected figure supported by the company’s increases in total revenues and net income for the
next five years.

The projections stated above forecasted an income statement for the next five years, which was
then used to attain present value cash flow figures and a terminal value. The intrinsic value that
resulted based upon our projections is $41.93. It is important to note that each projection does
influence the intrinsic value quite significantly. However, we feel that Panera Bread will expand
in future years since its current stores have proved to be extremely successful and there is a need
for the market that Panera Bread markets to. The estimated intrinsic value shows that Panera
Bread’s stock is undervalued slightly.

Ratio Analysis

Panera Bread’s financial ratios show that they have consistently been improving over the last
four years. Their profit margin has been steadily increasing, which shows that they have been
able to generate cash from operations greater than their expenses. Panera Bread’s return on
assets and return on equity have been improving showing that although their assets and equity
are growing their net income is growing at a higher rate. Their earnings per share have been an
impressive statistic. Panera Bread’s 2003 earnings per share doubled their 2001 figure. Looking
at their historical prices, one can see that their stock price has improved drastically since 1999.
Their price to earnings ratio is currently at 35.29, which indicates that Panera is still expanding in
the restaurant industry. Panera Bread has a considerably smaller market cap than its two larger
competitors, Starbucks and McDonald’s, but has a significantly higher growth rate than each
company. Panera Bread’s ratios reveal that they have been very competitive in the restaurant
industry in comparison to their competitors.

Another valuation method that can be used to find the intrinsic value of Panera Bread is using
their market comparables. This method uses their forecasted net income and trailing P/E ratio to
develop a horizon value. The present value of cash flows is then used to derive Panera Bread’s
value of equity. From these calculations the intrinsic value of $51.76 is developed. This price
states that Panera Bread’s stock price is currently under priced. However, we value the free cash
flow estimated intrinsic value of $41.93 greater. It is a more conservative estimate, which is
important since the predicted growth rates are so sensitive to the results.

Investment Recommendation

We feel that Panera Bread Company is a sound company with real growth potential. At this time
though, we do not feel that Panera Bread is a wise investment for the SIMM portfolio because
the FCFF and FCFE value the stock just above its current selling price. The small return of
about $2 is not worth the risk involved in buying the stock. We feel that this stock would be a
buy at the price of $33.50, which would give us a return on investment of approximately 20%.
At the onset of this valuation process Panera Bread was selling at $35.50, but due to a strong
month of November for stocks, Panera Bread’s price rose to $39.99. We would recommend this
stock as a buy if the price dips to a level that would result in a return of around 20%. If this does
occur depending on the reasons for this drop in price, we feel that Panera Bread would be a
strong buy for our portfolio.

On average, professional analysts have recommended investors to hold or buy Panera Bread
stocks. Most analysts such as JP Morgan believe that Panera Bread’s proper value is $42.00.
This re-emphasizes our valuation of Panera Bread’s stock price at $41.93. Analysts are
encouraged with Panera Bread’s recent growth rates. Panera Bread is 95% owned by institutions
meaning that the larger institutional investors like Panera Bread as an investment.

Panera Bread Company Website
Panera Bread: COO Resignation: View as Neutral Event
Panera Bread’s S&P Stock Report
We Think Panera Bread is a Fine Small-Cap Growth Stock

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