Are Cosi & Jamba Going Extinct?

Highlights include Cosi, Inc. (COSI - Analyst Report), Jamba, Inc. (JMBA - Snapshot Report), Starbucks Corp. (SBUX - Snapshot Report) and Panera Bread Co. (PNRA - Snapshot Report).

Negative cash flow and a threadbare balance sheet makes survival challenging for some restaurant operators.

As the recession deepens, cash flow tumbles and credit tightens, the restaurant industry is right-sizing excess capacity that was added to satiate shareholders' thirst for growth.

Virtually every operator has closed under-performing restaurants built in sub-par locations -- as competition for the "A" spots intensified -- while they dramatically scaled back expansion plans.

Some restaurant chains -- those that rapidly expanded despite sub-par profitability -- face extinction. Cosi, Inc. (COSI - Analyst Report) and Jamba, Inc. (JMBA - Snapshot Report) are 2 such examples.

Years of operating losses have drained Cosi's cash reserves, casting substantial doubt on its ability to survive the worst recession in decades. The bakery-café chain has generated negative free cash flow every year since going public in 2002, leaving few resources to fall back on.

Although Cosi has made moderate strides in its plan to return to profitability, it lacks the lean cost structure (G&A is twice the industry average) and solid cash position necessary to withstand what could be several quarters of sharply falling same-restaurant sales (down 6.2% in 4Q08) before the economy improves.

Likewise, Jamba is suffering from the effects of uncontrolled growth that has led to under-performing locations being opened and a loss of attention to innovation. Although management has formulated a turnaround plan that includes innovating new menu offerings, it would take a long time for new day-parts, such as breakfast or lunch, to become meaningful contributors -- as they have at Starbucks (SBUX - Snapshot Report) -- and beverage sales alone cannot support the stores. A costly $25 million cash infusion should buy it some time, but not much, as consumers cut spending and cash flow falls.

In contrast, bakery café operator (and Cosi competitor) Panera Bread (PNRA - Snapshot Report) is well-situated to weather recession-induced shrinking same-store sales, with a debt-free balance sheet, adequate free cash flow and a track record of profitability. Post-recession, well-positioned restaurant chains, such as Panera, will benefit from shrinking industry capacity and less competition for the "A" locations so crucial to high returns. But trading at 17 times 2009 estimated earnings, the risk/reward in Panera shares is not favorable at a time of declining customer traffic and no visibility to improvement.