AN ANALYSIS OF PANERA BREAD COMPANY, ITS

FINANCIAL STANDINGS & FUTURE GROWTH PROSPECTS

AS OF FISCAL YEAR END DECEMBER 31, 2013.

PANERA BREAD COMPANY

ANALYSIS

POPOV, LATCHEZAR || NOVEMBER 2014 || FINANCIAL MODELING || FI402A-14

I NTRODUCTION

This report entails my valuation of Panera Bread Company, here forth may be referred to with its ticker symbol PNRA. The company’s historical performance, existing growth and future outlook were examined to great detail. The analysis is begun by taking the most recent Annual Report 10-K for Panera Bread which occurred on December 31st, 2013, their fiscal year end date. Information was extracted from the Annual Report into excel, then multiples, averages and growth rates were taken for individual accounts in order to accurately forecast the next five year Pro-Forma Statements for Panera Bread. Once the Pro-Forma Statements were complete, a Discounted Cash Flow model was created to estimate the share value of Panera Bread based on the company’s future five year cash flows. However, in order to do this properly, a Weighted Average Cost of Capital and a Long Term Growth Rate need to be accurately calculated and estimated based on various parameters.

Through this rigorous process, I obtained a share price of $172.27 for Panera Bread. This share price was determined using a WACC of 8.2% and a long term growth rate of 4.0%. The reasoning and calculation behind these two numbers is explained in further detail below.

M ULTI- Y EAR F INANCIALS

Transferring data from the Annual Report of Panera Bread to an excel model was difficult as company’s tend to have dissimilar accounts to a standard Annual Report. To input the data, the 2010, 2011, 2012 and 2013 Annual Reports were used to obtain the full five year historical financial statements and to ensure no adjustments had been made after one of the Annual Reports was filed. In order to obtain an accurate total revenue growth rate, the revenue was split into four different accounts that appeared on the Annual Report. They include Bakery-café Sales, Franchise Royalties and Fees, Fresh Dough and Other Product Sales to Franchisees, and lastly Intercompany Sales Elimination. Although one might only split the revenues into three accounts, it makes sense to add the Intercompany Sales Elimination as well into the dispersion of the revenue account because the Intercompany Sales Elimination has a growth rate that was different from that on the Fresh Dough and Other Product Sales to Franchisees which is aggregated with the Intercompany Sales Elimination in the main section of the reporting. This breakdown can be seen on page 67 of the Annual Report 2013. Also, a graphical representation of each breakdown can be seen in Appendix 1.

Cost of Goods Sold is summed up by the Total Bakery-café Expenses and Fresh Dough & Other Product Costs. Pre-opening Expenses were added to the main financial accounts due to the strong year over year expenses. Furthermore, the Non-operating Income (Expense) and Special Items was “primarily comprised of a $2.2 million benefit from favorable resolution of legal and sales and use tax matters and immaterial items” in 2013 (10-K, 29). The 2012 account was “primarily comprised of e favorable outcome from certain unclaimed property and state sales tax audit matters, and immaterial items” (10-K, 29). One of the main discrepancy from the model conducted for this report and a standard company valuation model through a Discounted Cash Flow is the lack of a dividend payout for the Panera Bread stock. With this came difficulties in calculating an averaged Cost of Equity for the company based on multiple calculation methods.

The EBITDA of Panera Bread for 2013 comes out to $424,073,000, EBIT of $317,550,000 for 2013, and EBT of $312,720,000 in 2013. Further values can be seen in the attached financial model. This extensive historical analysis was conducted in order to obtain reasonable future growth rates or percentage of sales for most accounts. This allows us to forecast the next five years to a sufficiently accurate manner which is then used to calculate the free cash flow the company will have and therein the value of the company.

POPOV, LATCHEZAR || NOVEMBER 2014 || FINANCIAL MODELING || FI402A-14

A NALYSIS OF H ISTORICAL F INANCIALS

As mentioned above, the revenue breakdown was added to the Income Statement to ensure a more accurate total revenue sales growth in addition to the combination of two accounts to make up the Cost of Goods Sold. Past the Pre-opening Expenses and Dividend accounts mentioned and explained above, the Interest Expense and debt of Panera Bread caused some confusion when creating the model. As per the Annual Report, none of the Long Term Liabilities in the balance sheet below have any interest bearing. “As of December 31, 2013, we had no balance outstanding and were in compliance with all covenants under the Credit Agreement” (10-K, 32). Thus, in order to maintain the accurate historical financial statements no Interest Bearing Debt is Present in the historical financials although an Interest Expense is recognized. This is consistent with the Financial Analysis function in Bloomberg with the “As Reported” section which shows no Long Term Debt from 2001 to 2013. Due to this difficulty, an Interest Expense Annual Growth Rate was calculated and used to forecast the interest expense for the next five years. This approach seems to work out well since the interest expense has been steadily increasing since 2009 and not mention of its decrease through the Annual Report. A similar approach was taken for Pre-opening Expenses but instead was taken as a percentage of sales.

Although all the ratios can be seen at the end of the report, it is interesting to note that Panera Bread’s total cost, not including Pre-opening costs, depreciation, interest and tax expenses, is on average of 83.03% of sales over the past five years. Additionally, the effective Tax Rate comes out to 38.03% averaged over the past five years. This tax rate had dropped approximately 1.5% from 2014 to 2015, giving reason to using the average tax rate over the past five years instead of the most current tax rate as Benninga used in his example model. As explained in the Annual Report, taxes decreased because of "adjustments of previously recorded tax expenses to reflect the refinement of estimates for certain federal and state tax liabilities to amounts in filed returns, the settlement of tax audits, and an increase in federal tax credits” (10-K, 29). Thus, there is no evidence that the next few years will have a similar low tax rate.

On the balance sheet side, Goodwill was added to the main accounts and projected using a historical percentage of sales average. Here it is interesting to note that Panera Bread’s common stock has been a total of 3,000 for all of the past five years. Capital Surplus and Retained Earnings have both seen steady growth since 2009. Lastly it is important to note that Treasury Stock has been significantly increasing for Panera Bread in the past two years and was 546,570,000 in December of 2013 relative to 3,938,000 in December of 2009. For this reason, Treasury Stock made sense to use as the plug for the model – since it has varied and increased significantly over the past few years. Most of the other accounts did not work well when testing them out as the plug for several reasons. For example, Common Stock could not be used since it has not moved in the past five years. Cash did not work out well since it went into the negatives when using it as a plug. Similar problems were noted when trying to use Capital Surplus or Retained Earnings as the plug. Simply put, using any of the other accounts, the year to year numbers did not keep the same consistency with previous year as much as Treasury Stock. Moreover, it would have been difficult to otherwise project the Treasury Stock due to its significant recent increases.

Now that the plug was determined and all the historical ratios were ready to use for the projections, I was able to project the next five years and ensure that the balance sheet balanced. Once these projections were complete, the Free Cash Flow could be determined for the next five years. This is a genetic Free Cash Flow model where one takes the Net Income for the year, adds back deprecation, makes appropriate changes to net working capital that will affect the company’s cash, and subtract capital expenditures plus the increase in other assets, if any. From here on, the Weight Average Cost of Capital was used and Long Term Free Cash Flow Growth Rate to determine the terminal value of the company beyond fiscal year end 2018. The net present value of these cash flows are taken, the ending cash of 2013 is added in, liabilities are subjected and the remaining value is divided by the number of shares outstanding to obtain the implied share price of Panera Bread stock.

The most recent conference call was relatively positive as the company beat analysts Earning Per Share estimates of 1.4239$/share vs. the actual of 1.46$/share. The majority of the discussion was focused around “Panera 2.0” or the reconstruction of Panera Bread stores to increase the experience and satisfaction of customers by making the stores more efficient by ordering through a phone application, take orders directly from the tables, have employees bring you over your food, and a cozier environment. Although some of the questions asked by the analysts were not met with 100% clarity, the 2.53% greater EPS for the quarter and focus on Panera 2.0 seemed relatively positive for the company and its future outlook.

F INANCIAL M ODEL

Below you will see the five year projections for Panera Bread as well as the share price calculated through this model. For the full model, please see the attached documents with the excel worksheets.

Through these projections and the Free Cash Flow allocation, which can be seen in the attachments along with using a WACC of 10% as standard in many industry models, I obtained a share price of $120.05 which is significantly lower than the December 2013 ending price of $176.69 and the current price of $165.13 as of November 25th 2014.

W ACC D ETERMINATION

In determination of the Weighted Average Cost of Capital, the Capital Asset Pricing Model worked best in returning a required rate of equity that seemed reasonable and match that of values provided in Bloomberg. The CAPM model provides investors with a rule of thumb of their expected return on equity based on the time value of money for placing their capital under investment as well as the return they should can expect for the risk they are taking on during the investment – this is where beta plays a major role. Below you will find the equation along with the variable explanations for CAPM:

I obtained a required rate of return of 8.36% using this process and equation mentioned above; using a Risk Free Rate of 3.03% that I obtained from Bloomberg’s historical 10 year treasury rate. The entirety of the model can be seen in the excel attachments at the end of this report. However, it is important to note that where the data was obtained for the calculations. Appendix 2 and 3 will provide a screenshot of Bloomberg’s values for the P/E Multiple and Equity Cash Flow Payout Ratio of the S&P 500 along with its Anticipated Growth of Equity Cash Flow. Although Bloomberg provided a Growth of Equity Cash Flows of 11.553% for the United States Market, I saw fit to take the historical five year return of the S&P 500 and average it with the Bloomberg expected growth. Thus obtaining a more reasonable expected return for the market. Therein I obtained a market risk premium of 7.09%.

The cost of debt in this scenario does not apply since Panera Bread did not have interest bearing debt on their books at the time of the fiscal year end. Therefore, the WACC is only determined by the cost of equity presented from the CAPM since the Gordon Model of determining the cost of equity was omitted due to the lack of dividends.

Through averaging the cost of equity based on the classic CAPM and tax-adjusted CAPM, I obtained a WACC of 8.22% which seems fairly reasonable considering the range of Panera Bread’s WACC over the past few years based on the Bloomberg historical WACC shown in Appendix 4. In this appendix you can see the graph of the historical WACC which is currently at 7.2% and peaked at approximately 13.75%. Lastly, Appendix 5 shows the Bloomberg calculated WACC for the fiscal year end December 2013 of 9.15%. Thus my calculated WACC is almost exactly in between the current level and historical level of WACC at the year-end data 2013.

F INAL V ALUATION

Using the computed WACC described above, along with a long term free cash flow growth rate of 4.0%, I obtain an implied Panera Bread value per share of $172.27 which is moderately close to the ending price of Panera Bread on December 31, 2013 of $176.69; a 2.568% overvaluation of the market price at the end of the 2013 fiscal year and a current undervaluation of the market price as of November 25th 2014 with a stock price of $165.13. The entirety of the process is mentioned above and can be noted on the excel attachments as well.

Through these valuations and analyses, I would recommend a Hold rating of Panera Bread based on the financials as of fiscal year end 2013. The Hold rating is most appropriate here since my implied value per share is marginally different from that of the fiscal year end 2013 price and the current price. At the fiscal year end price, the market was slightly overvaluing Panera Bread and thus one should have not invested in PNRA. However, it was only 2.568% overvalued and thus a sell rating would not be appropriate either. At the current market price, the upside to the intrinsic value of the company is only 4.32% that is again not significant enough for an investor to allocate capital to – the margin of safety is marginal. An upside of at least 5.0% should be observed before considering investing, but this is subjective to the particular investor. Unless an investor has significant reason to increase or decrease the WACC or Long Term Growth Rate, then they should hold off on the purchase or shorting of Panera Bread.

C ONCLUSION

This report analyzes the financial standing and implied share value of Panera Bread through the historical financial performance of the company. With the company’s historical financials, the model provided sets annual growth rates or percentage of sales ratio for each account in order to project each account for the consecutive five years. Then Dividends, Capital Asset Pricing Model and the cost of equity and debt is considered in order to determine an appropriate Weight Average Cost of Capital. The WACC along with the long term growth rate is then used to determine the terminal value of the company beyond the five year projection; WACC is also used as the discount rate for obtaining the present value of the cash flows. Once the present value of the cash flows is obtained, the ending cash amount is added in, liabilities are subtracted and the implied value is divided by the shares outstanding to obtain a share price for the stock. Using this method I was able to determine that Panera is currently fairly priced by the market and was slightly overpriced at the fiscal year end date 2013.

A PPENDICES

1)

2009

2010

2011

2012

2013

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

0%

5%

10%

15%

20%PNRA, Total Sales and Sales Growth, 2009-13

Sales Year-on-year growth

Sal

es (

$ m

illi

on

)

Sal

es g

row

th

2009

2010

2011

2012

2013

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

0%

5%

10%

15%

20%

25%

PNRA, Bakery-cafe Sales and Sales Growth, 2009-13

Sales Year-on-year growth

Sal

es (

$ m

illi

on

)

Sal

es g

row

th

2009

2010

2011

2012

2013

0

20,000

40,000

60,000

80,000

100,000

120,000

0%

2%

4%

6%

8%

10%

12%

PNRA, Franchise Royalities & FeesSales and Sales Growth, 2009-13

Sales Year-on-year growth

Sal

es (

$ m

illi

on

)

Sal

es g

row

th

2)

2009

2010

2011

2012

2013

050,000

100,000150,000200,000250,000300,000350,000400,000

0%2%4%6%8%10%12%14%16%18%

PNRA, Fresh Dough & Other Prodcut Sales and Sales Growth, 2009-13

Sales Year-on-year growth

Sal

es (

$ m

illi

on

)

Sal

es g

row

th

2009

2010

2011

2012

2013

-200,000

-150,000

-100,000

-50,000

0

0%

5%

10%

15%

20%

25%

30%

PNRA, Intercompany Sales Elimination and Growth, 2009-13

Sales Year-on-year growth

Sal

es (

$ m

illi

on

)

Sal

es g

row

th

3)

4)

5)

A DDITIONAL R EFERENCES

2008 2009 2010 2011 2012 20130.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

-

50,000

100,000

150,000

200,000

250,000 PNRA: EPS versus Profits

Earningsper share

Profitsafter taxes

EP

S

Pro

fits

2009 2010 2011 2012 201325.00%

26.00%

27.00%

28.00%

29.00%

30.00%

31.00%

PNRA: Net Plant, Property and Equipment to Sales

-16% -11% -6% -1% 4% 9%

-22%

-17%

-12%

-7%

-2%

3%

8%

13%

18%

23%

f(x) = 0.751712733764933 x + 0.011338014789247R² = 0.204285577736093

Computing the Beta for PNRAusing monthly price data for PNRA and the SP500

SP500 return

PN

RA

Re

turn

W ORK C ITRED

Panera Bread Investor Relations; Annual Report 10-K (2010, 2011, 2012, 2013), Conference Call, Panera

2.0. Recent News Releases. (October 24-25). Panera Bread Company Website.

https://www.panerabread.com/en-us/company/investor-relations.html

Bloomberg L.P. SPX P/E Multiple, United State Market Growth Rate & Dividend Payout Ratio, WACC

Verification, PNRA Historical WACC, PNRA Financial Analysis Function (October 20-

25th, 2014). Bloomberg database. Bentley University Terminal.

Wyatt Research; “3 stocks With High Dividend Payout Ratios Every Investor Should Own.” Additional

sources verifying the S&P payout ratio.

http://www.wyattresearch.com/article/dividend-payout-ratio/