The start of the year was difficult for the main market averages, and the restaurant industry continued to decline. However, although Papa John’s (PZZA) is in a better performing (pizza) group than its restaurant peers, the stock has fallen more than 18% from its all-time highs, underperforming the restaurant group by 600 basis points since November. Had this sharp correction left the stock at an attractive valuation, it would present a buying opportunity, with Papa John’s far better positioned than most other segments of the foodservice space. However, at ~31x FY2022 earnings estimates, I still don’t see a sufficient margin of safety here above $116.00.
In November, Papa John’s released its third quarter results, announcing quarterly revenue of $512.8 million, an 8% year-over-year increase. Although this is the company’s lowest sales growth rate in over a year, Papa John’s reported sales growth of 17% in the prior year period, indicating impressive results given the difficult year-over-year comparisons. These strong results were driven by moderate unit growth and strong model sales growth, with international and domestic model sales up 6.9% and 8.3%, respectively. Given the strong results combined with improving margins, the company is on track for triple-digit earnings growth this year ($3.38 vs. $1.40).
However, as I noted in my most recent article in November, when Papa John’s was posting strong results and annual EPS was on the verge of hitting a new all-time high, much of that growth was already embedded in the stock price. Indeed, the stock has traded at more than 36 times FY2022 earnings estimates, a premium of more than 20% to its historical multiple. The stock has since returned to reality, falling nearly 20% from its highs despite two new bulls, including plans to expand into Africa with Kitchen Express (60 restaurants) and a massive development deal with FountainVest. Partners for new stores in China. .
As for the most recent deal with China, the partnership with FountainVest (one of Asia’s leading independent private equity firms) includes the opening of 1,350 new stores in southern China d ‘by 2040. This is a huge deal for Papa John’s and crushes its suggestion that it had an opportunity market of over 1,000 restaurants in China. Indeed, following this new agreement, the company’s footprint in China would exceed 1,500 restaurants, including the 200 restaurants it already has in the country. Combined with the significant national development agreement with Sun Holdings for 100 locations in Texas and the South by 2029, Papa John’s has a very impressive development pipeline and should have no problem maintaining and potentially accelerating its rate. unit growth of around 4% in 2021.
So why is the stock under pressure?
While recent development agreements indicate the addition of approximately 1,500 stores, which translates to nearly 25% growth over the current number of Papa John’s stores (~5,500 restaurants), I believe this growth has already been partially priced into the stock at its November highs. Indeed, PZZA is up nearly 370% in just 18 months from its lows in the first quarter of 2020. Additionally, while Papa John’s reported higher restaurant margins on a two-year basis in the third quarter of 2021, it may be more difficult to sustain this margin expansion going forward. Indeed, Domino’s (DPZ) recently reported that its food basket will increase 8-10% from 2021 levels due to inflationary pressures. This led to the company reducing its $7.99 wings from ten to eight.
To date, Papa John’s has been able to circumvent industry-wide margin pressure, with gross and restaurant margins rising from 2019 levels. The company has benefited from limited-time offers and menu innovations that boosted average control, like Papadias, Epic Stuffed Crust and its recent BaconMania promotion. However, with Domino’s not only reporting a much higher average basket compared to 2021 levels, but also taking steps to reduce its wing portions, the margin outlook for Papa John’s is less clear in 2022.
The good news is that the company continues to have impressive average unit volumes, surpassing $1 million in 2020 and growing further in 2021. As a result, the unit economics are still quite attractive to potential franchisees, even if the margin outlook may suffer a slight deterioration due to persistent inflationary pressures. Additionally, while Papa John’s may see some margin pressure through 2022 in company-owned stores, its margins are still holding up much better than those of its peers, most fast food names getting away with it. shooting much better than their casual counterparts.
Evidenced by names like Red Robin (RRGB) reporting significant margin compression, with margins falling 300 basis points from Q3 2019 levels at 12.5%. So, with inflationary pressures continuing to wreak havoc on the industry, Papa John’s and other fast-food/fast-casual names like Chipotle (CMG) seem like the best houses in a bad neighborhood if one wants to be exposed to the industry. Let’s take a look at the company’s earnings trend below:
As noted above, Papa John’s is on track to increase annual EPS by more than 140% in fiscal 2021 based on current estimates, which would also represent a new annual EPS record. This represents a massive recovery from the massive drop in sales in 2018, with annual EPS sliding nearly 50% year-over-year. Looking ahead to fiscal 2022 and 2023, earnings growth is expected to continue, which is not surprising given the expected steady unit growth in both domestic and international markets. However, while Papa John’s ranks high on growth, it ranks low on value, as evidenced by Seeking Alpha’s Quant ratings above. A closer look at the valuation explains why the stock currently sits on a “D” rating.
Evaluation and technical image
Looking at the chart below, we can see that Papa John’s has historically traded at around 28x earnings and closer to 25x earnings since its stock market debut (1993). At the current share price of $116.00, the stock has gone from an insane valuation of around 38 times forward earnings to around 31 times earnings, but this is still well above its historic earnings multiple. . Furthermore, even if we compare the current earnings multiple to its 10-year average of 34x earnings, the chart below shows that the ideal time to buy the stock has been closer to 23x earnings, not more than 30x future profits. This is evidenced by the chart below, which shows the stock’s previous lows.
On a P/EBITDA basis, this figure also suggests that Papa John’s is not yet attractively priced, with the stock posting an EBITDA yield of around 5.5% or just over 18x EBITDA. Over the past ten years, the stock’s EBITDA multiple has averaged around 16x, and the best buying opportunities have been below 13x EBITDA (Q3 2014, Q1 2016, Q3 2018). Obviously, with a low probability of another major failure like the Schnatter saga, a return below 12x EBITDA is unlikely. However, even using FY2022 EBITDA estimates of $6.60, the stock is still trading at around 17.5x EBITDA, or 10% above the historical multiple. In summary, it’s hard to say there’s a margin of safety here even after the 18% correction. Indeed, the stock went from extremely overvalued to slightly overvalued.
As seen in the long-term picture above, PZZA has come within 5% of testing the top of its multi-year channel, and as I warned in November, this could present a tricky spot for the stock. Indeed, testing of this upper channel line has not been favorable to the stock, with earlier testing leading to corrections of over 30%. As it stands, PZZA is down 18% from its highs, but it is still at the upper end of its long-term channel. For investors looking for the most attractive buy points and willing to be patient, the best time to buy Papa John’s and put it away was pullbacks to the lower third of this trading range, which would necessitate a drop in below $80.00 per share.
If we zoom in on the PZZA technical chart above, we can see that the stock has clearly formed a double top in the $140.00 area, and there is now a new resistance level at $138.50. Meanwhile, with the stock recently hitting a fresh multi-month low, the next strong support zone only comes in at $102.25. So while the stock has pulled back sharply from its highs, PZZA is only slightly below the midpoint of its trading range. As a general rule, I prefer at least a 4 to 1 reward/risk ratio for entering new positions, and PZZA’s reward/risk ratio is currently only 1.60 to 1.0. Therefore, we are not yet at a low risk buy point. This is based on $22.30 up from resistance and $13.95 down from support.
Papa John’s continues to enjoy strong unit growth and is expected to increase full-year EPS by more than 22% from fiscal 2021 levels ($4.13 vs. $3.38), which is extremely impressive given that it will outpace earnings growth by about 140% this year. However, while the recent breakout to fresh full-year EPS highs is a bullish development, I still don’t see enough of a margin of safety to justify paying for the stock here at around 31x FY2022 earnings. , while I think Papa John’s is a name to watch if it drops below $102.00, I currently see much better value elsewhere in the sector. One name that looks more appealing is Restaurant Brands International (QSR), which trades at around 18x fiscal 2022 earnings estimates.