Einstein Noah Needing More Dough?

Falling Comps Could Leave Einstein Noah Needing More Dough

Einstein Noah Restaurant Group, Inc. (BAGL - Snapshot Report) announced that it will report 4th quarter earnings on March 2nd, after the market closes. We think comps, which turned negative in the 3rd quarter for the first time in four years, will continue to slide and weigh on earnings into 2H09 or longer, depending on the economy.

For the last 5 years, price increases have been supporting comps, as traffic declined. Though management has changed the product mix to add more lunch offerings, including salads, and some higher-priced items such as smoothies, comps will likely worsen as consumer spending on dining outside the home continues to fall.

The stock price has increased 77% from its 52-week low but remains 66% off its 52-week high, in part due to concerns about BAGL’s leverage (2.2x versus covenant maximum of 2.75x) and its ability to meet a $57 million preferred stock maturity in June 2009.

At this juncture, liquidity is paramount. With the drastic deterioration in the economy, declining comps are likely to squeeze the company’s free cash flow, despite declining cap ex.

Another potential downside catalyst for the stock are what we believe are very aggressive consensus EPS estimates. Our 4Q08 and full-year 2009 estimates are $0.34 and $1.13, well below the consensus estimates of $0.36 $1.30, respectively.

Thus, although trading at less than 5x our 2009 EPS estimate, the growing downside risk is not worth the potential reward. That the CEO of the last 5 years just left the company only adds to the uncertainty.

When the economy improves, however, we think BAGL is positioned to increase EPS at a low-teen CAGR [compound annual growth rate] over several years, while boosting ROIC [return on invested capital] from mid-single digits, through 2.5% to 3.5% + comps and 10% unit growth, heavily weighted towards licensed units and franchises. The company has culled underperforming units from its system – roughly 45% of the system – and a more profitable unit base remains.

Read the full analyst report on BAGL