Tag Archives: PAPA JOHN’S

PAPA JOHN’S (PZZA) UP 10%, “IN PLAY” – WHAT TO DO NOW?

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PAPA JOHN’S “IN PLAY” – WHAT TO DO NOW?

We have written several articles regarding Papa John’s (PZZA) in the last sixty days, since John Schnatter became a persona non grata in mid July, the latest on 8/8 after he had been forced out and sales were disclosed to have been down double digits in July. You can read our commentary below:

July 17th, here:

https://www.liptonfinancialservices.com/2018/07/papa-johns-pzza-the-latest-restaurant-situation-a-buy-or-a-sell/ – PZZA closed that day at $52.09

July 23rd, here:

https://www.liptonfinancialservices.com/2018/07/papa-johns-pzza-should-you-be-long-or-short-this-one/ – we disclosed that we had bought the stock, PZZA closed that day at $46.56

and August 8th, here:

https://www.liptonfinancialservices.com/2018/08/papa-johns-pzza-reports-q2-stock-down-again-how-bad-is-it/ – we reiterated our bullish position – PZZA closed that day at $38.94

Activist investor, Trian Fund Management LP, controlled by the well known Nelson Peltz, is one of a number of potential buyers who have indicated interest in acquiring Papa John’s. The company has retained investment bankers to “shop” the company, and it is not clear whether Trian’s interest, or that of others, is a result of that process.

In any event, the due diligence process is under way, and PZZA is trading up about 10% this morning to the $54-$55 per share. “Let the games begin.” While PZZA is still statistically cheap, relative to other franchising  companies, like Dunkin’ (DNKN), Restaurant Brands (QSR), Wendy’s (WEN) and (especially) Wingstop (WING), there are some unique uncertainties here, among which are:

  • To what extent John Schnatter, who owns about 30% of the stock will muddy the waters with his ongoing desire to be involved. To date, he has indicated an unwillingness to back away, but the company has already moved ahead without him in their corporate imagery.
  • Sales were damaged materially through the summer, and we do not know whether there has been any rebound, or stability at the very least. This is a top line business, and it would make a huge difference in terms of giving hope to potential buyers if sales have at least stabilized.
  • There are lots of class action lawyers around, ready to muddy the waters should a deal be announced, claiming, among other things, that the transaction is undervaluing the company.

On the other hand, as we pointed out in our previous articles, it is in the interest of all the major stakeholders to get a deal done, including John Schnatter. Unfortunately, Schnatter may not realize that yet, and it could take some more time for that reality to sink in.

Putting it together, we doubt that a deal will be done at much more than $60 per share, and the process could drag on for months. Should a transaction be delayed, or not seem likely, due to continuing weak sales or Schnatter’s requirements, PZZA could fall back to the high 40s.

Longer term, six months to a year out, or beyond, we think there is a likelihood that PZZA could trade a lot higher. Chipotle (CMG), for example, hired a new CEO, and, before anything much in terms of tangible results has even occurred, CMG is up over 50%. Relative to PZZA Over the next several months, with the foreseeable uncertainties, there is not much more upside potential than downside risk. We advise long term investors to stick with at least part of their position. Shorter term traders would be well advised to take partial profits, lowering their cost basis on the remainder.

Roger Lipton

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PAPA JOHN’S (PZZA) REPORTS Q2 – STOCK DOWN AGAIN, HOW BAD IS IT?

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PAPA JOHN’S (PZZA) REPORTS Q2 – STOCK DOWN AGAIN, HOW BAD IS IT?

Papa John’s reported Q2, dismal, as expected. You don’t need us to rehash all the operating details. Everyone knew the results would be poor, that the Company and their founder, namesake, and largest shareholder are having a protracted battle. The questions revolve around how much damage has been done in terms of sales, profits, reputation and future potential. There is widespread speculation that PZZA is a takeover candidate (including by ourselves), and debate continues as to whether the current problems can be overcome or whether the competition (including Domino’s) is just too tough and whether the brand is beyond repair. We refer our readers back to our previous report on PZZA, datedJuly 23rd, which outlined why all the major stakeholders: current management, franchisees, board of directors, stockholders, debt holders, and even John Schnatter, would be best served by a going private transaction, and the current financial parameters could still support that process.

The earnings release and the Conference Call updated observers on the results to date, sales trends through July, guidance for all of ’18 was adjusted downward, operating initiatives were described to rectify the sales trend, and management strongly defended their decision to move aggressively ahead without John Schnatter as corporate spokesperson. Suffice to say that there is a great deal of work to be done to deal with a 4,600 unit franchisee system, including redirection of a marketing effort in an industry segment that is always highly promotional. On the other hand, PZZA has competed, and grown successfully, for many years, and it was less than twelve months ago that the brand was widely admired. We encourage our sufficiently interested readers to fill in further details from the full earnings release and Conference Call transcript. We are trying to provide here a timely interpretation of the most important issues, and present a reasoned conclusion as to how the situation plays out.

Among the most important issues: Sales Trends, Unit Growth Prospects, Debt Covenants

The Same Store Sales Trend

First quarter systemwide North American comp sales were down 5.3%, International comp sales were up 0.3%. In the second quarter, North American same store sales were down 6.1%, International comp sales were down 0.8% so there was a sequential deterioration of about one point. North American comp sales in July (from 7/2 until 7/29) were down approximately 10.5%. When questioned on the Conference Call about the Q2 sequence into July, Management said: “the cadence of comps through Q2 were consistent with the 6.1% Q2 decline….after the July 11 article…we saw a precipitous drop of roughly 4% from the trend…we do think we have stabilized a number there…it’s very early into Period 8…but we do think we have experienced the significance of the decline…have provided our outlook based on the infancy of what we have seen and that’s why we have re-guided to a negative 7-10% for the year.” Our interpretation is that the -7 to -10% implies an assumption that the July negative 10.5% range continues or even worsens to the mid teens in H2. Management, of course, hopes that comps firm up and the year’s result is closer to the 7 than 10. International comps are now expected to be between from -2 to +1% for 2018, several points worse than previously indicated.

Unit Growth

Among the changes of guidance from management, net global unit growth has been adjusted from a positive range of 3-5% to a range of flat to 3%. Virtually all the unit growth continues to be international, and those sales have been far less affected than domestic locations. There was quite a bit of discussion on the Conference Call about unit closings and royalty relief. Management indicated that they are working with franchisees, as always, to alleviate financial problems at specific situations. With the current sales trends, margins are naturalized squeezed for all operators, unit growth can be expected to be slower and closings can even increase. While it is natural to be concerned about the rate openings and closings, there has been very little indication (so far) of wholesale franchisee disillusionment. Internationally there has been steady unit growth with hardly any closings. In the more mature North American market, there were 79 locations closed in H1’18 (42 in Q2), but 44 new locations opened in H1, for a net reduction of 35 on a base of over 2700 units.

Our conclusion here is that it is pretty early to be overly concerned about a collapse of a franchise system that was doing rather well for many years until about nine months ago. This situation could obviously change if the current negative sales trend is not, at the very least, stabilized.

Bank Covenants

The Leverage Ratio is defined as outstanding debt divided by consolidated EBITDA for the most recent four quarters. The Interest Coverage Ratio is defined as the sum of consolidated EBITDA and consolidated rent expense, divided by the sum of consolidated interest expense and rent expense for the most recent four quarters.

Per the 10Q filing for the second quarter, the actual leverage ratio and interest coverage ration in Q2 were 3.4 to 1.0 in each case. The Permitted Leverage Ratio was not to exceed 4.5 to 1.0 at the end of Q1, subsequently decreasing to 4.25, decreasing over time to 3.75. The Permitted Interest Coverage Ratio is not less than 2.75 to 1.0, with no indication that it is structured to change. As the 10Q says:

“We were in compliance with all financial covenants as of July 1, 2018. Based on our revised lower financial forecast, we plan to work with the banks within our Credit Facility to evaluate options with the covenants to mitigate the possibility of violating a financial covenant in the future. If a covenant violation occurs or is expected to occur, we would be required to seek a waiver or amendment from the lenders under the credit agreement. The failure to obtain a waiver or amendment on a timely basis would result in our inability to borrow additionalunds or obtain letters of credit under our credit agreement and allow the lenders under our credit agreement to declare our loan obligations due and payable, require us to cash collateralize outstanding letters of credit or increase our interest rate. If any of the foregoing events occur, we would need to refinance our debt, or renegotiate or restructure, the terms of the credit agreement. ”

On the conference call, management indicated that the leverage ratio is expected to be in excess of 4.0 (stilll OK) at t he end of ’18, no doubt based on the assumptions most recently provided, including N.A. comps negative in the 7-10% range.

While we can’t know the exact definition within all the above ratios, both ratios will no doubt narrow if the second quarter (and July) trends persist, or get worse, and it makes sense that the Company negotiate potential adjustments to the current credit agreement. The bottom line here is that there is still substantial operating cash flow, EBITDA, and free cash flow, by any definition. Absent a very substantial additional decline in sales, the credit situation should be controllable. This, in our mind, seems a compelling reason for all parties involved to negotiate an amicable parting of the ways between the Company and John Schnatter. Even Schnatter’s recent statement that he has the interest of all stakeholders leaves opoen his departure as an acceptable solution once the current emotional atmosphere cools.

Conclusion:

We feel that sales will more likely stabilize than deteriorate, followed by at least modest improvement, over the course of Q3 and especially during Q4 when new marketing efforts should take hold and the YTY comparisons get easier as well. We expect that the most important stakeholders in this equation, specifically John Schnatter, current management and the Board of Directors will come to a rational conclusion that toned down rhetoric is in everyone’s interest. Meanwhile, there is a great deal of P/E capital looking for a home, and the valuation of the Company supports PZZA as a buyout candidate. We continue to believe that, over the next six months to a year, there are more ways to win than lose from these levels. If the Company remains publicly held, the stock could rebound sharply with just a stabilization of sales, let alone resumption of positive comps. Chipotle stock is up over 200 points since they hired a new CEO, and sales have yet to improve meaningfully. There’s lots of press coverage right now regarding PZZA, but this too shall pass, and nobody died or went to the hospital with this situation.

Roger Lipton

 

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PAPA JOHN’S (PZZA) – THE LATEST RESTAURANT “SITUATION” – A BUY OR A SELL?

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Papa John’s International, Inc. – (PZZA) – THE LATEST “SITUATION” WITHIN THE RESTAURANT INDUSTRY – A BUY OR A SELL?

As background for the following piece, readers may want to peruse our basic descriptive piece, dated 3/27/18, available here:

https://www.liptonfinancialservices.com/2018/03/papa-johns-pizza-international/

It’s hard to miss the news that John Schnatter, founder, largest shareholder with 29% of the equity, and company spokesperson, has resigned from the Company. The circumstances have been widely documented in all kinds of press reports, and we believe have been amplified by the fact that everything in America is “politically charged”.

Opinions vary widely as to what the future holds for the Company and the stock. There are lots of obvious reasons why customers could shy away from the pizza, further weakening the sales trend that already turned down in Q1’18 and further penalizing the stock that is trading at 22x calendar ’18 estimates of earnings. Though the dividend yield is 1.75% at the current stock price, some could question whether a new CEO will maintain the dividend when earnings are down sharply, especially when long term debt is over $500M against negative equity as a result of stock buybacks. Uncertainty is always a substantial negative when evaluating the desirability of owning a particular stock.

The argument has been made perhaps no other consumer products company has been so dependent on the image of its founder, “Papa John” Schnatter who has consistently appeared on TV, with Peyton Manning and others, touting the “Better Ingredients, Better Pizza”. Observers have recalled that Steve Ells, Howard Schultz, Dave Thomas, and Jimmy John have been the face of their Brands, but not to the extent of Papa John.

However, we suggest that the “face” of PZZA has more been “Better Ingredients, Better Pizza” than the personality of John Schnatter. How long it takes PZZA to rebound from this PR nightmare is anybody’s guess, but nobody died (as with Jack in the Box), went to the hospital (as with Chipotle) or lived through the operational problems at Starbucks when Howard Schultz had stepped aside. Jimmy John’s sandwich shop have continued to prosper even after Jimmy’s hunting habit was criticized by the anti-gun lobby.

At Papa John’s, to the contrary, even after same store sales turned down by 5.3% in Q1’18, not only did nobody die, and we never heard that the product had deteriorated, the stores were dirty, delivery service was poor, or there was negligence from an operating standpoint. The delivery pizza business has always been competitive, especially in light of Domino’s technological lead, so the PR problem relating to the NFL, and the delay of rolling out a new campaign could well have cost a few points of same store sales performance. As for the latest press coverage relating to Schnatter’s inappropriate remarks, the reaction of his Board, and his own attitude toward the episode,  we believe it will fade as the 24 hour news cycle moves on. Ninety days from now, the concern at Papa John’s will be about new products, new marketing, how the search for a new CEO is coming along, and technological innovation that can help catch up with Domino’s. One can argue that the departure of John Schnatter will work out for the best in the long run because the brand will no longer be so dependent on a single personality’s reputation.

Meanwhile, the stock, while not what we would consider dirt cheap, is selling at a much lower valuation than its peers. There are over five thousand stores in 45 international countries and territories. The long term debt at $568M is only a little over 3X trailing twelve months EBITDA. Other well established franchise companies are carrying debt at 5-6X EBITDA, so PZZA could be leveraged further to buy back common stock or taken private at a premium to the current price. The current enterprise value at 12.5X trailing twelve month EBITDA and 22X calendar ’18 estimated earnings (even if those estimates come down) is materially cheaper than peer asset light franchising companies such as DNKN (17.9X and 26.0X), QSR (20.5X and 23.9X), DPZ (25.6 and 33.7), and WING (42.5X and 61.2X). DIN and JACK are selling at comparable multiples as PZZA but have had operating issues. YUM’s valuation is also comparable but is much more comples, with three brands, very dependent on China for future growth, and has an enterprise value fifteen times as large with 45,000 (9X that of PZZA) systemwide restaurants.

In summary, we think there are a number of ways to win here, and there is enough substance to avoid much downside risk over the intermediate to long term. There are hundreds of billions of dollars of private equity capital looking for a home, and everybody loves “asset light”, “free cash flow” stable situations.  Anything can happen in today’s environment that sometimes allows for outsized stock moves in unexpected, and sometimes irrational direction. Aside from possible short term volatility, we think there is more upside potential than downside risk with PZZA (“Better Ingredients, Better Pizza”) at this time.

Roger Lipton

 

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