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Jonathan Poland
Jonathan Poland
Articles (475)  | Author's Website |

Is This the End of Papa John's?

Not if the company can find a new papa to help shareholders

August 10, 2018 | About:

For the six people who don’t know the company, Papa John’s International (NASDAQ:PZZA) runs the third largest take-out and pizza delivery chain in the U.S., and has built it by giving away franchises and taking a 5% chunk of the sales.

Back in May, the founder and chairman of the board John Schnatter made a racist comment on a conference call that was made public last month. After Schnatter confirmed the incident and resigned as chairman, the company went into full blown kill-the-king mode, fighting to get “Papa John” off the marketing materials. Since then, the stock is down 20%, but that was just the latest down trend for the company. At this time last year, the stock was hovering around $80. Now, after being cut in half thanks to Schnatter’s continued incendiary remarks, investors have a buying opportunity.

Publicly traded restaurants tend to trade with multiples of 21x but historically, Papa John’s has been closer to 30. Domino’s Pizza current trades with a 41.5 price-earnings ratio. Papa John’s reported numbers on Tuesday with second-quarter earnings per share of 49 cents, missing estimates by 5 cents and revenue of $407.96 million, a decline of 6.2% year-over-year. All things considered, not a bad showing.

This from a company that, again, has done a good job of growing over the years. Sales and profit are up big since 2008 and thanks to share buybacks, its earnings per share were up over 335% until this year. While Papa John’s has a favorable position in the $125 billion global pizza market, no company can survive if the public perception takes away from consumer confidence.

From my view, I’ve always liked Papa John’s when there wasn’t another good choice around. The problem for industry incumbents is that startup costs are low and just about anyone with a decent recipe can turn a profit.

Compared to local pizzerias, none of the big names poses a threat from a taste standpoint. However, when you have $88 million in free cash flow a year and spend $160 million on sales, general and administrative costs, even the best one-off pizza joint in town has to worry. Because, while food costs rise, Papa John’s will still be able to keep its prices low thanks to economies of scale. And, low prices always win more sales.

Pizza will always be one of the most affordable and lovable foods. It’s popular across every demographic, and it's designed for convenience. Digital ordering is a big deal with Papa John’s and should continue to win consumers. In fact, digital orders represent 60% of sales, 70% of which are from mobile. The company is clearly on the right side of societal change and the ecommerce capabilities should help it continue growing market share at the expense of mom-and-pop operators.

Papa John’s is a brand name with 85% of its store base franchised, giving shareholders a piece of the massive royalty stream produced by the franchise owners, which converts nicely into free cash flow since the financials aren't burdened with the investments required by company-owned restaurant models. Until recently, the company looked even more attractive since the founder-manager also owns 25% of the stock. Now, the company needs a new papa.

Thankfully, John is a very common name. Anyone could be Papa John. Just look at Kentucky Fried Chicken, the company Schnatter made the racist comments about. It just hired a new Colonel Sanders, Jason Alexander. John Goodman would be a good fit as Papa John. John Malkovich maybe? John C. Reilly or John Witherspoon if you want more comedy to wipe clean this past year. The company could even bring back Payton Manning and just call him Papa John. The hunt for the next Papa John should be the marketing slogan, and it should start immediately.

As for the stock, with the company looking to over $3 a share in 2019, it looks cheap here. Any good publicity where the public thinks it’s doing the right thing going forward will cause the multiple to expand. Long term, the dividend should continue higher as well. It’s a bargain at this price.

Disclosure: I am not long/short any stock mentioned in this article.

About the author:

Jonathan Poland
I used to manage money. I still publish my thoughts on stocks here on GuruFocus, mainly on big cap companies. I rarely write about stocks that I own. Thank you for reading.

Visit Jonathan Poland's Website

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