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Saturday, December 18, 2010

A Coming Trading opportunity -- Panera Bread (PNRA)

Panera Bread is one of the long term success stories in the stock market. Over the last 15 years, the stock has risen by a multiple of about 40 times. It closed on Friday at $105.75, and it has been hitting all time highs for the last few weeks. Indeed, the stock now presents a great opportunity for a short term trade in my opinion. I believe that the stock will decline substantially right after the beginning of the new year. Here are the reasons:

First, Panera has been going up all during the last year. Essentially every person who holds the stock has a profit on it. Since the year is ending, almost everyone who wants to sell will wait for next year when the tax on the capital gain can get put off for an entire year. When the tax rates were scheduled to rise next year, this was much less important, but now that the current rates have been extended, the tax situation should push a major amount of selling into the beginning of January.

Second, because Panera has had such a strong 2010, there are a number of money managers who have or will buy it as window dressing in December. These folks want to show their clients on their list of year end holdings that they chose stocks well in 2010. They think that when clients see that Panera is in the portfolio, the clients will be pleased with the abilities of their portfolio manager. Most of these folks who buy the stock as window dressing at the end of December also sell the stock at the start of January. This provides another push downward for the stock after the first of the year.

Third, Panera's stock has actually gotten ahead of its value in my opinion. Panera's estimated earnings for 2011 come in at $4.36. This prices the stock at a P/E multiple of over 24 based upon the next year's earnings. That seems to be full value for this stock; it is now so big that it cannot continue to meet high growth targets as it did in the past. This idea is not unique to me; Goldman Sachs recently resumed coverage of PNRA at neutral and commented on the declining growth rate that it expects from the company.

Fourth, this pattern has happened to Panera in the past. I have watched the stock closely since the days when it was still Au Bon Pain in the mid 1990's. In fact, at the time that Au bon Pain acquired St. Louis Bread, a chain of about 20 restaurants, and renamed the St Louis Bread concept Panera, the company was far an away my largest holding. No long thereafter, the company sold off the Au Bon Pain concept and renamed the entire company Panera. The stock rise began almost immediately as the Panera restaurants proved to be great successes. The stock rose from about $5 to about $24 in the first year and basically duplicated the today's situation where everyone had a profit and money managers wanted to use the stock for window dressing. In the first two days of January, the stock dropped 20% on heavy selling, but then it bounced back almost immediately and continued to rise. The same thing happened two more times.

So what is the best way to play this trade. I strongly recommend against shorting Panera. Over the years, too many people have lost too much by going short on this stock. Any bet on the short side has to done in a way that there is a maximum amount placed at risk. One way is to buy puts that are near but not at the strike price. For example, at the close on Friday, you could buy the january 100 puts for about $1.50. For ten of these puts, you would only put at risk $1500. Were the stock to decline by $4 or $5 in two days, the volatility in the put price would rise and the intrinsic value would also kick in, and both factors would provide a nice profit. I would not buy the put now, however. We still have two weeks left in the year, and there may be more movement in panera extraneous from the basic causes that provide the basis for this trade. The time to buy the put is the last day or two of the year.

Other folks might recommend using a bear spread to play Panera, but I do not like that. The move in January, if it comes, will be short and quick. You will need to watch the stock and pull the trigger quickly to take advantage of the situation. A bear spread will not move nearly as rapidly as a long put.

One final note: This is another speculative trade. It is not meant for any portion of your portfolio other than the small amount that you set aside for higher risk trades. Panera could surprise and just go up. The market as a whole could move up and ruin the trade. Nevertheless, I think it is a good percentage play. You should be in during the last week of 2010 and out by the third day of 2011.

Disclosure: although I have owned Panera for 15 years, I recently divested myself of my last stock. I am not going to do the trade recommended above, since I will be away on vacation during the first week of January and will not be able to watch the trading so as to react if and when the stock drops down.

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