PZZA - Papa John's: The Pizza Giant Is A Sell

Summary

• Papa John's International, Inc.'s sales growth has stalled, as shown in Q4 earnings.
• A big push internationally to open new stores comes at a time of economic uncertainty.
• Labor costs remain very high, while food input costs are starting to normalize.
• Papa John's International stock is expensive for the limited growth in earnings.

Papa John's International, Inc. ( PZZA ) stock had a nice run with the market rebound in the first 5 weeks of 2023. Pressure has begun mounting, though, and PZZA stock is taking a hit following its just-reported quarterly earnings.

It remains our belief that consumer confidence will slip in the coming months as a result of ongoing inflation, high interest rates, and more and more layoffs by big businesses. For now, the labor market is very tight, but that hurts restaurants because they need to pay more to retain labor. While demand is robust, there are signs of weakness. Margin pressure is building because food is just very expensive. Labor costs are also high, and it has been hard to find workers in the service industry due to the tight labor market. The Federal Reserve's battle against inflation looks like more hikes and higher rates for longer will be needed. That is just not good for consumer spending or businesses that rely on a strong consumer. Still, people need to eat. Pizza is a cheap way to feed a family, compared to sit-down restaurants. Let us discuss the quarter.

When analyzing restaurants, there are several key metrics we focus on. We first look to revenue to see if there are growing top-line sales. Perhaps most importantly, we also closely look to comparable sales. Further, we like to see controlled expenses and margin power. We also look for store-count changes such as the closing of underperforming stores and the opening of new ones in favorable locations.

Papa John's beats on the top and bottom line

In the just-reported fourth quarter , sales were about flat from a year ago. Revenues were $526 million, down 0.5%. We believe that the company's growth will continue long-term despite this slowdown. Food costs are starting to come down, and the company has pricing power. The company has seen its growth stall but also has seen margins compress. We think lower ingredient costs this year could be a hidden benefit. This is why shares have collapsed as they have. The revenues of $526 were a slight beat of $2 million, while earnings also beat thanks to better-than-expected sales and margins.

International sales slip

Sales were up when we back out of the negative impact, refranchising 90 stores in early 2022. While about flat from last year as reported, controlling for these costs, revenues were up 2.8%. Volumes were strong, as were same-store sales. Well, the same-store sales increased as did store count in domestic markets, but slipped in international markets, boosting sales. For the quarter, global system-wide restaurant sales were $1.20 billion, up 2.8%.

Comparable sales were down, though. North America comparable sales were up 1% from a year ago and up 26% on a three-year stacked basis. International comparable sales were down 3% from a year ago but are up 20% on a three-year stacked basis. As far as store growth, factoring in closings and remodels, it had global net store growth of 117 stores in the quarter, comprised of 145 new stores (28 franchised in North America, and 117 international), while they closed 28 stores total.

Papa John's margins and earnings power

While sales were up on an adjusted basis for currency, expense management is a key metric to watch in restaurants now. Labor costs are indeed high. But that said, operating income takes all this into account. Operational income fell $1.9 million, or 5.1%, in Q4 2022 as compared to a year ago, primarily due to higher commodity costs, wage inflation, and expenses around digital investments. Making adjustments, operating income was $38.2 million, still falling $3.7 million from a year ago.

Net income fell 5% versus last year, to $23 million. On a per share basis, income was $0.66 as opposed to $0.67 in the prior-year quarter, falling 1%. On an adjusted basis, earnings per share fell to $0.71 from $0.75. This beat consensus by $0.04.

Our take is that the PZZA stock is still too expensive here. We would prefer you let the stock fall below $75 before buying. Let it get there once again. The balance sheet has some cause for concern, but we like the cash being given back to shareholders.

Papa John's Pizza balance sheet

Papa John's does have a debt burden of $597 million. This is likely the biggest risk to be aware of when investing here, given cash and equivalents on hand are $47 million. Net cash provided by operating activities fell to $117 million from $185 million last year.

That said, the company is still shareholder-friendly. The company is repurchasing shares, having bought back 361,000 shares for $30.0 million, and continues to have $300 million remaining on the authorization. Finally, the company pays a $0.42 dividend per share quarterly, or just under 2% annually on the yield . We think you let shares pull back to where they are yielding a good 2.25%, which brings valuation metrics into levels that are more appropriate. The growth just does not justify the price here.

Looking ahead

As we look ahead, we see Papa John's International, Inc.'s revenue in 2023 up 3%-6% to $2.15 to $2.25 billion and earnings of $3.20-$3.50. This would be growth of about 15% at the midpoint, which does not justify a price that is over 25X FWD EPS. This comes as we still do not know how bad a recession will be.

Take home

Papa John's International, Inc.'s performance has stalled. It is a tough time with these high costs of food and labor. We will argue that pizza is largely recession-proof, but a pinched consumer will eat out less. Interest expense could increase on future debt with high rates. Labor is still tight. Inflation is coming down, which will benefit food input costs, but it is still a tough market. We view Papa John's International, Inc. shares as a sell here, and not a buy until $70-$75.

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