Papa John’s Leaves Something To Be Desired (NASDAQ:PZZA)

Papa John’s International, Inc. (NASDAQ:PZZA) has seen its stock get absolutely crushed this year. This is much like many other stocks in the market, but restaurant stocks have been hit particularly hard. Today, the stock is trying to find some footing following its just reported quarterly earnings.

We cover a range of stocks and sectors, but are very selective about the restaurant business in general because of how hit-and-miss it can be even in “normal” times. But, right now, we are seeing rampant inflation, causing input costs to rise. While so far economic data does not reflect an economy that is softening much despite the Fed’s actions, the middle class and upper middle class have seen their portfolios decimated and retirement accounts gutted this year. Just awful.

Folks, mark our words, consumer confidence will slip in coming months, and we think most companies reporting so far show that while demand is robust, there are signs of weakness. Turning to Papa John’s, this company seeks to provide a quality product at an affordable cost, but it cannot keep its prices low and maintain its margins. Raising prices helps, but you do not want to price out the consumer. Margin pressure is building as food is just too expensive. Labor costs are also high, and it has been hard to find workers in the service industry. As a stock, it has been crushed, down over 40% from highs, as the market is in turmoil as a result of never-ending inflation and the Federal Reserve’s battle to take it down by raising rates.

That said, after this massive crash in the share price, Papa John’s stock is much more reasonably valued. We believe it is the type of company that is somewhat recession-proof, but this is especially true from an investment standpoint, as turmoil is baked in. When times are tough, people still need to eat. And, if they are tough, they often eat cheaper – and pizza fits the bill.

What to look for with Papa John’s

When examining the business of restaurants, there are several key metrics we like to look for. First, we like to look to revenue to see if there are growing top-line sales. Second, we want to see controlled expenses to ensure any rise in sales generates net income growth (e.g., good margins). Third, we look for store-count changes such as the closing of underperforming stores and the opening of new ones in favorable locations. Perhaps most importantly, we also closely look to comparable sales.

Papa John’s is a little mixed on these metrics. With the stock having been crushed, we think you can nibble at shares in the $60s. Now, let us turn to the numbers.

Papa John’s just reported headline results were a double miss

In the just-reported third quarter, a trend of growth in sales stalled. Revenues were about flat at $511 million. The company, like so many others, is facing challenges and working on overcoming them. The company’s growth will continue long-term despite this slowdown. What we will say is there were mixed results globally. Papa John’s stock has seen an incredible selloff in the last year, but with football back, consumers trying to save money for the holidays, and the threat of recession, we think this will be a boost for pizza chains. The company has seen its growth stall, but also has seen margins compress. This is why shares have collapsed as they have. The revenues of $511 were a slight miss of $3 million, while earnings also missed due to high expenses. Let’s first address these revenues.

Sales fall slightly, but more internationally

Sales were up when we back out the negative impact refranchising 90 stores. While about flat from last year as reported, controlling for these costs revenues were up 3.1%. Not terrible. Volumes were strong, and this is welcomed news, but what about 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 0.5%.

Comparable sales were down, though. In North America, same-store sales fell 0.8% during the quarter versus the year-ago period. International same-store sales fell 10.1% during the quarter. There were currency issues to contend with, however. If we control for all currency, comp sales rose 0.9% in North America, and fell 0.4% internationally. This shows you how the strong dollar is killing businesses that transact internationally. As far as store growth, factoring in closings and remodels, it had global net store growth of just 18 stores in the quarter, comprised of 66 net new stores (17 franchised in North America, 1 company owned, and 48 international) while they shuttered 48 total.

Costs weigh on Papa John’s margins

While sales were up on an adjusted basis for currency, we do note that the costs to generate these revenues were higher than we would like. Expense management is a key component to watch in restaurants now.

Operational income fell $19.1 million, or 50%, in Q3 2022 as compared to a year ago, primarily due to higher expenses. Making adjustments, operating income was $33.6 million, still falling $7.3 million from a year ago. Much of the pain is due to acceleration in commodity costs, wage inflation, and the economic downturn in the UK. Costs and expenses were up $17 million from last year despite revenue stalling.

That said, turning to income, we see that net income fell 72% versus last year as reported to $8.3 million. On a per share basis, income was $0.23 as opposed to $0.79 in the prior year quarter, falling 71%. On an adjusted basis, earnings per share fell to $0.54 from $0.83. This missed consensus by $0.07, it was mostly due to the increased inflationary expenses. But the valuation and growth metrics of the company are both getting attractive, in our opinion, although the stock is not cheap by any means. Of course, for the moment, growth has stalled on a year-over-year basis but looks great on a three-year stacked basis.

The price of the stock is down so much that all the pain is largely priced in for a buy below $70. Let it get there. The balance sheet has some cause for concern, but we like the cash being given back to shareholders.

Domino’s Pizza balance sheet

We should point out that the company does has a debt burden of $549 million. This is likely the biggest risk to be aware of when investing here given cash and equivalents on hand are $36 million. Net cash provided by operating activities fell to $76 million from $193 million last year. Ouch.

That said, the company is being shareholder friendly. The company is repurchasing shares, having bought back 229,000 shares for $19.5 million, and continues to have $330 million remaining on the authorization. Finally, the company pays a $0.42 dividend per share quarterly, or 2.3% annually on the yield. All things considered, the stock is a buy.

Take home

Papa John’s International, Inc. stock is down so much, as is performance. It is a tough time with these high costs. We think any slowdown in sales is temporary plus we caution you to consider the strong dollar. Pizza is largely recession-proof, and with this decline in share prices, the value has improved and the yield has improved too. There is some debt, but the company continues to grow globally. We think you can buy Papa John’s below $70, and as such we recommend selling puts here to define your entry price, and if not assigned, you keep the cash.