PZZA - Papa John's Stock: Double Upgrading And Outlining The Play

2023-11-19 08:08:45 ET

Summary

• Papa John's stock has reached a three-and-a-half-year low, but appears to be reaching an inflection.
• We were the only analyst group at Seeking Alpha with a sell rating nearly all year, as the stock continued to erode.
• The company has implemented cost-cutting efforts and adjusted its menu and pricing to boost margins.
• Operating margin is projected to double in the next 4 years, with ongoing international expansion.

Papa John's International, Inc. ( PZZA ) stock has now entered levels where we believe traders and investors can both start to come in for a play. Our firm was the only Seeking Alpha analytical team to rate shares a sell this year, and we rated the shares a sell back in February of this year. In that column, we thought shares would be attractive closer to $70. Well, we are here at $66 which is a three and a half year low for the stock.

While there are macro pressures on consumers, labor inflation, and stiff competition, many of the inflationary pressures are easing. Further, the company has put forward cost cutting efforts, and has worked with the menu and pricing to boost margins. We upgrade shares to a buy. Let us discuss the key metrics we look for in a company like this, but first, here is a sample trade from the team at BAD BEAT Investing:

The play

Target entry 1: $66.00-$66.45 (30% of position)

Target entry 2: $64.50-$64.75 (33% of position)

Target entry 3: $63.00-$63.25 (37% of position)

Target exit: $74.50 if one leg, $73 if 2 legs, $71.50 if three legs

Stop loss: $56

Options considerations: Options considerations are only discussed at our investing group though there are put entry strategies we would consider.

Discussion

We now upgrade to a buy as we see a turnaround in key metrics in 2024. Labor inflation remains an issue but has tamed. Supply chain issues have been worked out and food commodity costs have abated. While competition remains, and that will never change, the company's efforts to control costs will continue to boost margins going forward in our estimation. In looking to the just reported quarterly earnings. When analyzing restaurants, there are several key metrics we hone in on. We always first look to revenue to see if there are growing top-line sales, or if there is the expectation for growing sales. Make no mistake, there has been pressure and that was a reason we had a sell rating. Now valuation has come down, and key metric inflection in 2024 is our thesis. That said, we also closely look to comparable sales. Further, we like to see controlled expenses and margin power, which we see improving in 2024. We also look for store-count changes such as the closing of underperforming stores and the opening of new ones in favorable locations. Let us discuss.

Papa John's missed on the top and bottom line

In the just-reported third quarter, sales were up slightly from a year ago. Revenues were $523 million, up 2.3% from a year ago. We believe that the company's growth will continue long-term despite this slowdown, but the revenues were a miss of $7.3 million, while earnings also missed thanks to those worse-than-expected sales. However, global system-wide restaurant sales were $1.23 billion, a 5% jump from the prior year third quarter.

While that was tough news we note that many ingredient costs are starting to normalize, and the company has pricing power to boost margins going further. The company has seen its growth stall and in the past we had margin concerns. However we think those concerns will abate in 2024. Management alluded to this in the release, saying they will "increasing fixed operating margin by 100 points in each of the next four years". In fact, management forecasts them to double. This has us bullish.

Comparable sales

Comparable sales were have started to rebound some this year. Looking by geographic areas, North America comparable sales were up 3%. There was higher transaction growth which helped drive 6% comparable sales at domestic company-owned restaurants and 2% comparable sales growth at franchised restaurants. Still international sales are looking to base out before growing. International comparable sales were down less than 1% from a year ago, and we see that as a win.

Store growth

In looking at overall sales we need to not just consider comparable sales, which were positive, but also store counts including new openings and closings. it had global net store growth of 45 stores in the quarter, comprised of 70 new stores (15 franchised in North America, and 55 international franchise locations), while they closed 25 stores total. As of the end of September 2023, there were 5,825 Papa John's locations in 48 countries and territories. The company expects 245 to 260 new stores to open in North America for the year.

Papa John's margins and earnings

We like the stock now ahead of margin expansion, and we saw margin expansion and comp growth in North America. Operational income jumped nicely in the quarter to $32 million, or 64% versus last year Making adjustments, operating income was flat however at $34 million. Net income nearly doubled versus last year, to $15.9 million. However on an adjusted basis, earnings per share fell to $0.53 from $0.54. This missed consensus by $0.04.

Looking ahead

As we look ahead, we like the bit of a dividend that is paid, though keep an eye on long-term debt which is $769 million and interest expenses have risen. That said as we look to ahead past Q4 and into 2024, we see Papa John's International, Inc.'s revenue in 2024 up 2.5%-5.5% to around $2.22 billion give or take $250 million and earnings of $2.70-3.00. This would be growth of about 15% at the midpoint. At this price we are at 23X FWD EPS. While the growth may not yet justify the valuation, this stock has long been valued well over 25X, despite mixed growth. Moreover, with margin expansion in the works, these numbers may be conservative.

Take home

We move to a buy on shares given future margin expansion, sales that have based out, domestic store growth, transaction volume, and ongoing international expansion.

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