PAPA JOHN’S PIZZA (PZZA) MAKES NEW RECOVERY HIGH, SHOULD YOU CHASE IT ?

Papa John’s (PZZA) reported its third quarter, ending 9/29, the first under the leadership of new CEO,  Robert Lynch. It is safe to say that Lynch, in place only for two months at the moment , had nothing to do with the reported fundamental results. The results, Adjusted, along with Lynch’s excellent reputation, were sufficiently encouraging to take the stock up about 10%. The adjusted earnings per share was $0.21 vs. $0.19 a year earlier, but the most important aspect was that the comp sales have bottomed out, up 1.0% in North America and up 1.6% internationally.

Robert Lynch arrives at Papa John’s with great credibility, and will hopefully provide the consistent and informed leadership that has been lacking over the last two years. Franchisees, who have been undoubtedly in distress, are no doubt encouraged by Lynch’s arrival, and will support him every way they can.

Our object here is to reflect on the current valuation relative to the current EBITDA run rate, and we will accept the non-recurring nature of Adjustments as the Company suggests. We will compare today’s valuation with that of Papa John’s, at its peak in late 2016. In evaluating the stock at this point, it seems to us a comparable situation to that faced by Chipotle, which fell from grace about four years ago, brought in new management about two years ago, and the stock, CMG, has outraced the earnings recovery to make new highs.

THE PREVIOUS PEAK VALUATION

At the end of 2016, the market value of the equity was $90/sh. X 37.7M shares outstanding, or $3.39B. Adding the $300M of long term debt provided an enterprise value of $3.69B. This was 17.8x the EBITDA for calendar 2016 of about $207MM

TODAY’S VALUATION

Today, at the end of 2019, the market value of the equity is $61/sh. X 31.6M shares outstanding, or $1.93B. Adding the $346M of long term debt provides an enterprise value of $2.28B. This is about 19.8x the apparent Adjusted EBITDA for the year ending 12/31/19. This, by the way, is in the same range of EBITDA multiples that other large scale publicly traded franchise systems sell for.

THE POSSIBILITY OF RECOVERY

We view Papa John’s rebound at least as probable as that achieved by Chipotle. There are lots of differences to be sure. Chipotle is largely company owned, Papa John’s franchised. Chipotle had food borne illness problems, Papa John’s had leadership/political problems. There was a leadership crisis at both companies with both founders, Steve Ells and John Schnatter losing credibility for very different reasons. The QSR industry is more competitive than ever, but PZZA had the scale to compete two years ago, and there seems to be no major reason why they can’t regain most, if not all, of their previous market share.

THE CHIPOTLE COMPARISON

The following charts show the revenue and earnings statistics, and the stock price performance, per Bloomberg, for CMG over the last five years. You can see that revenues and earnings peaked in calendar 2015, the stock turning down at the end of 2015 as the food borne illness issue arose. You can see that the stock bottomed in late 2017-early 2018, just before Brian Niccol arrived as the new CEO. The stock moved almost immediately from about $250 to $400, before Brian had learned where the bathrooms were (especially since headquarters was moved from Denver to San Diego, at a cost of over $100M). Be that as it may, Chipotle has made great strides, in all kinds of ways, and the stock recently hit a new all time high above $800. It is worth noting that the $13.88 eps estimate for 2019 is still below the $15.43 high in 2015. So….that’s Chipotle.

Now we have Papa John’s. The following charts shows the earnings statistics and the stock price chart.

The stock price peaked in late 2016, with earnings reported at $2.55 in 2016, no doubt expected to be higher in 2017 than the $2.61 reported. In any event, the stock has bottomed in 2019, with PZZA under the control of interim management. It is interesting to us that the Enterprise Value at the bottom, this year, was very close to the 17.8x trailing EBITDA at the end of 2016. With the stock price up from the 40s to the low 60s, the Enterprise Value of about 19.8x the trailing Adjusted EBITDA does not seem outrageous to us. In fact, valuations in terms of Price to Earnings or Enterprise Value to EBITDA are almost always highest at the bottom of a cycle, when earnings and EBITDA are depressed, and the stock price is hope for some sort of recovery.

CONCLUSION

The current price of PZZA seems to reflect a very small portion of a potential recovery. There are no certainties, of course, but Robert Lynch is a qualified leader, the Company has a strong enough balance sheet to support an extended recovery period, if necessary, and the franchise system has little choice but to make every effort to do their part. Unit growth has been mostly international in recent years, those sales trends never suffered as much as those in North America, so that third of the worldwide 5,000 unit system should continue to provide unit growth. Overall, we think it likely that the run rate of EBITDA will increase materially over the next two to three years, if not sooner, and the stock price could move in lockstep.

Roger Lipton