Papa Johns: Put A Slice In Your Portfolio

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Papa John’s International (PZZA) is one of the world’s largest pizza companies that operate in the quick service restaurants (QSRs) segment of the industry.

The stock carries CFRA’s highest investment recommendation of 5-STARS, or Strong Buy. As of Dec. 31, 2020, there were 5,400 Papa John’s restaurants, comprised of 4812 (89%) franchised and 588 (11%) company-owned restaurant units operating domestically in all 50 states and in 49 countries. Of the total units, 3,289 (61%) were in the U.S. and Canada and 2,111 (39%) in international markets, including the U.K., China, Korea, Russia, and Chile.

As the fruits of its recent transformation increasingly take hold, we view the company as well-positioned to sustain some of its recent market share gains since the onset of the COVID-19 lockdown, which accelerated customer demand for its products.

Amid the resulting restrictions on eat-in dining, PZZA significantly pivoted to its digital sales channels, including online ordering and expanded partnerships with the major third-party delivery aggregators. In 2020, the company added more than 30,000 associates to meet the surge in demand amid the lockdown.

Meanwhile, it also significantly ramped up its customer loyalty program (Papa Rewards), which recently notched a milestone of more than 20,000 members at the end of Q2 2021 (up more than 30% from the previous year).

In addition, PZZA’s increased focus on menu innovation was recently highlighted by its rollout of a popular offering, Epic Stuffed Crust, which helped to drive a significant increase in ticket and customer traffic in H1 2021.

Over the past year, these initiatives in the aggregate have led to a significant acceleration of comparable sales in North America and internationally, extending a recent streak of outsized gains through Q2 2021.

We project total revenue of about $2.01 billion in 2021, rising 11% on top of 12% growth in the prior year, with accelerated development hinging on management’s plans to add another 220 to 260 net new stores in 2021 (for a potentially sustainable 4% to 5% global net unit growth per year).

With further traction in the digital channels, we see continued strong comparable sales growth of high-single to low-double digits in North America and international markets, with strong gains for both franchised and company-owned restaurants. We forecast revenue growth of 4.2% in 2022 and project operating margins of 8.0% in 2021 and 8.2% in 2022, a significant expansion versus 5.3% in 2020.

Results should benefit from efficiency and productivity gains as well as expense leverage and some easing of labor cost pressures partly offset by higher delivery and commodity (cheese) costs, combined with technology/cloud investments.

After depreciation, amortization, and interest expenses, with a projected effective tax rate of 20%-23%, and some share buybacks, we forecast EPS of $3.13 in 2021 and $3.24 in 2022. Our 12-month target price of $140 reflects a P/E of 43x our 2022 estimate, a notable premium versus peers and the five-year historical average forward P/E of 32x.

We think PZZA’s premium valuation is warranted by further upside we see on the company’s strategic transformation. In May 2021, the company simplified its balance sheet upon retiring all the shares of its Series B convertible preferred stock.

Consequently, we believe the company has ample liquidity and financial flexibility to sustain its ongoing shareholder initiatives, including its dividend (with an implied recent yield of 1.1% after a 56% dividend hike in August) and share repurchases (under a $75 million program).

We note potential downside risks to our rating and target, including a global economic recession and/or decline in consumer spending, and potential reputational damage related to a lingering corporate governance fallout with the company’s founder and former controlling shareholder.

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