Loved by the street, management may have set the bar high for 4Q.
The sell-side analyst community loves PNRA with 65% of analysts recommending the stock as a buy (there are no sell ratings). It is easy to figure out why with the company posting +10% comparable sales growth and north of 200 bps of YOY operating margin growth in the first half of the year. The comparisons get more difficult from here, however, with the company lapping sequentially better same-store sales growth in the back half of the year - particularly in 4Q10. Additionally, PNRA is facing its toughest YOY margin comparison during 3Q10.
This is not new news as the company guided to lower, yet still impressive, comp growth of +5-6% growth in 3Q10 and +4-6% growth in 4Q10 with flat to 50 bps of margin expansion in the back half of the year. Based on recent top-line trends, the +5-6% same-store sales guidance for the third quarter seems achievable as the high end of the range only implies a 20 bp acceleration in two-year average trends from the prior quarter. The fourth quarter comp guidance is more concerning, however, as it implies a 125 to 225 bp acceleration in two-year average trends from the reported level in 2Q10. Based on management’s guidance, this sequential improvement in trends is expected to be driven by a sharp increase in 4Q10 transaction growth on a two-year average basis while average check growth is expected to decelerate slightly.
Transaction growth ran positive for PNRA during the first half of the year but average check growth has accounted for about 7% of the 9.8% comp growth. Average check growth held steady on a two-year average basis during the second quarter whereas transaction growth decelerated 70 bps.
This recent level of average check growth is impressive but is likely unsustainable. We have seen other restaurant companies in the past use pricing and average check growth to support same-store sales growth, but this often takes a toll on traffic growth (please refer to the charts below that highlight the similarity in trends between the relationship of average check growth and transaction growth for Panera and Chipotle). Ultimately, restaurant operators need to get more people in their restaurants.
Panera management attributed the 2Q10 average check growth to the strength of the company’s summer salads, its meal upgrade program (offers the customer the opportunity to get a baked good for $0.99 with the purchase of an entree and a beverage) and to its growing catering sales, which carry higher average check per transaction. PNRA will begin to lap the increase in catering sales during 3Q10 as catering sales first turned positive in 3Q09 (+3.0%) and quickly accelerated from there (+14% in 4Q09, +20% in 1Q10 and +24% in 2Q10).
This, combined with the fact that the company is lapping 4.2% average check growth from 4Q09, will put increased pressure on average check growth during the fourth quarter. Management guided to 3.0% average check growth in 4Q10 relative to its expectation for 5-6% growth in 3Q10 and the reported 6.5% and 7.7% growth in 1Q10 and 2Q10, respectively. The company expects to offset this lower level of average check growth with +1-3% transaction growth, which I said earlier assumes a significant increase in two-year average trends. I am not convinced management will be successful in achieving this targeted transaction growth so I am currently modeling +3.0% comparable sales growth for 4Q10 (relative to management’s guidance of +4-6%). My estimate still implies a 75 bp acceleration in two-year average same-store sales trends and a 110 bp improvement in two-year average transaction growth trends from 2Q10 levels.
New MyPanera Loyalty Program:
Panera is rolling out its new loyalty program system-wide during the fourth quarter and expects the program to lift comp sales by +1-2% during the quarter. Management’s comp and transaction growth guidance assumes this sales lift. The company is confident in the success of this program after testing it in 23 markets where results have shown that it strengthens customer relationships and has a meaningful impact on frequency of visits. I do not doubt that over time, this program will drive frequency, but a +1-2% lift in the first quarter it is rolled out seems like a stretch. Like I said, I am assuming transaction growth will get better during the fourth quarter, but based on the deceleration in trends during the second quarter, getting to +1-3% growth in 4Q10 seems aggressive. Time will tell.
Howard Penney
Managing Director
