Einstein Noah Restaurant Group (BAGL)

Einstein Noah Restaurant Group (BAGL) is suffering the effects of constrained consumer spending, reporting its first quarter of negative comps in four years. We expect comps to remain negative and weigh on earnings into 2H09 or longer, depending on the economy. Longer-term, however, we think BAGL is positioned to increase EPS at a low-teens CAGR over the next several years, while boosting ROIC from mid-single digits, through 2.5% to 3.5% +comps and 10% unit growth, heavily weighted towards franchises.

The company has culled under-performing units from its system roughly 45% of the system and a more profitable unit base remains. The stock price has fallen more than the overall market (down 65% in 3 months), in part due to concerns about BAGL's leverage (2.2x versus covenant maximum of 2.75x) and its ability to meet a preferred stock maturity in 2009.

However, we think these concerns are overblown, as the company is building cash reserves and generating increasing free cash flow on declining cap ex requirements, despite declining comps.