Papa John's (PZZA) is a Hedgeye Restaurants Best Idea Short.
EVENT DETAILS:
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Robert Lynch, CEO of Papa John's, expressed optimism on the organization's most recent earnings call, highlighting its dedication to quality, innovation, and value. The company reported a 3% increase in North American comparable sales, driven by higher transactions rather than price increases, contrasting with industry trends. The company-owned restaurants saw a 6% SSS growth, benefiting from lower food costs and improved restaurant-level margins. However, the adjusted operating income remained flat due to the dilutive impact of newly acquired UK restaurants. Lynch highlighted the company's digital prowess, menu innovation, and strategic pricing, contributing to its growth. Despite all this, we see some challenges ahead.
Investing Thesis:
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International Issues Can Get Worse: The UK acquisitions negatively impacted overall operating income despite solid sales growth in North America. International comps were down less than 1%, with mixed regional performance. The company is experiencing dynamic international operating environments, particularly in the UK, Asia, and the Middle East. The UK market's current drag on profitability and the cautious international outlook may concern investors. The downward adjustment of net new unit development guidance reflects uncertainty and potential market challenges.
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Persistent Margin Pressure: In 3Q23, adjusted operating margins decreased slightly to 6.4%. Domestic company-owned restaurant margins improved by 130bps due to lower food costs and labor efficiencies. The UK acquisitions impacted profitability negatively, which might improve over time, but the line of sight is limited. Adjusted operating margins for 2023 are projected to be down compared to 2022, mainly due to the UK acquisitions.
- Competitive Landscape and Promotions: DPZ has been aggressive with promotions, such as offering 50% off discounts for a couple of years. The move to a delivery platform will accelerate PZZA's need to discount more. The most significant negative is that the increased promotions will not drive category growth. The situation is furthered, but the company focuses on premium innovation and delivering value across all segments, including limited-time offers (LTOs), core menus, and aggregator channels.
TOPICS TO BE DISCUSSED:
- Delivery Expansion and Efficiency: With the growth in delivery competition, can PZZA invest in its delivery infrastructure, perhaps through advanced logistics, better packaging technology, with third-party delivery services, to fend off the competition.
- Technology Investments: Incorporating technology for better customer experience, such as mobile ordering apps, AI for order taking, and advanced CRM systems, is a key trend. Companies in the pizza delivery space are known for their tech-forward approach, how does PZZA stack up?
- International Expansion: There is potential in emerging markets, and companies that are expanding internationally could offer growth opportunities. This could involve assessing how well companies like Papa John's and Domino's are adapting to different cultural tastes and preferences. Unfortunately for PZZA this is a source of uncertainty.
- Customization and Personalization: Companies that offer more personalized experiences, whether through customizable menus or through marketing, may have a competitive edge. An important component of this is the company's loyalty and marketing programs. PZZA is investing in developing strong customer loyalty programs and innovative marketing campaigns to retain customers and attract new ones.
- Supply Chain Resilience: Given recent global disruptions, PZZA is investing in supply chain resilience, perhaps through local sourcing or vertical integration. Will they be better positioned to handle future challenges, or is this challenge still an issue?
