PZZA SHORT DECK
Date & Time: Tuesday, November 14th, at 12:30 PM ET.
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.
KNAPP October
In October 2023, the U.S. casual dining sector witnessed a nuanced performance. Over four weeks, comparable restaurant sales saw a modest increase of +1.9%. However, sales are driven by price, with a slight decline in guest counts, which fell by 1.8%. In October 2023, on a 2-year basis, comparable sales increased by 127bps to 4.5%, and traffic improved by 120bps to -1.8%.
Our calculation of implied pricing fell from +4.6% in the first week of the month to +2.7% in the last week. When we place these figures in the context of the previous year, a more detailed picture emerges of slowing sales trends. October 2023's sales growth lags behind the exceptional performance of October 2022 by 520bps. To recall, October 2022 was a standout period, registering a robust 7.1% rise in comparable restaurant sales, marking it the second-best month of that year. Regarding guest counts, October 2022 saw a just -2.4% decrease, making it the fifth-best month of 2022.
As Mr. Knapp noted, 2023 is shaping up to be a year of unprecedented heat globally, with temperatures reaching record highs. This year is on track to become the hottest ever recorded, and with the influence of El Niño, it's anticipated that 2024 could surpass even these extreme levels. June through October 2023 have already set new global records for high temperatures. A notable peak was reached on July 6, 2023, marking the highest global temperature recorded. In Phoenix, Arizona, this extraordinary heat wave manifested as an unrelenting stretch of 31 consecutive days, with temperatures soaring above 110 degrees. This intense heat has had tangible impacts on business, particularly in the retail and hospitality sectors. For instance, Florida witnessed a noticeable dip in sales during August 2023. Miami, grappling with severe heat, saw a significant downturn. Even Orlando's famed theme parks, usually bustling with visitors, reported a drop in attendance, especially among local guests, as they contended with the oppressive heat. The effects of such extreme temperatures extend beyond reduced customer foot traffic. Restaurants, for example, face increased operational costs, particularly in air conditioning, as they strive to provide a comfortable environment for their patrons.
He also noted that in the fourth week of October 2023, an intriguing trend emerged in the top 20 TV markets for comparable restaurant sales. He ranked these markets based on their performance in comparable sales, comparing 2023 with the same period in 2022. This comparison offers valuable insights into the evolving dynamics of the restaurant industry across different markets over the month, and three of the four bottom markets were in Florida: 17 was Tampa (-2.2% - +2.3%), 18 was Miami (-2.5% - +0.8%), and 19 was Orlando (-3.9% - +1.6%)
Denver was the worst-performing city in October.
Krispy Kreme 3Q2 Financial Performance is messy
Krispy Kreme reported 3Q23 EPS of 0.03 excluding items, which was below the FactSet consensus of 0.06 (the estimates ranged from 0.04 to 0.07.) The company's revenue for 3Q23 was 407.4 million, slightly missing the FactSet expectation of 413.9 million. However, it fell within the estimated range of 405.6 to 423.9 million. Krispy Kreme reaffirms its revenue guidance of 1.65 to 1.68 billion, in line with FactSet's 1.68 billion estimate, and (A)EBITDA Guidance is maintained at 205 - 215 million, compared to FactSet's 214.7 million. Capital Expenditures: Expected to be 7% to 8% of revenue, an increase from the previous guidance of 6.6%. Krispy Kreme raised its guidance for capital spending primarily to support growth and expansion, particularly in the U.S. Direct-to-Store Delivery (DFD) network. This decision was influenced by several factors and a short-term negative for the stock:
- Expansion of DFD Network: A significant portion of the increased capital expenditure is allocated to expanding the DFD network in the U.S. This involves investing in new production hubs and logistics to increase the company's reach and efficiency in delivering fresh doughnuts to various retail points.
- Investment in Manufacturing Capacity: Krispy Kreme is investing in manufacturing capacity to support the growth of the DFD network and potential partnerships (like the one being explored with McDonald's). This includes building new production hubs and enhancing existing ones to cater to increased demand.
- International Investments: Part of the capital expenditure increase is also attributed to investments in international markets. This includes the impact of foreign exchange rates on these investments.
- Support for New Initiatives: The company also invests in new initiatives and innovations to drive future growth. This could include technology upgrades, store renovations, and other strategic investments to enhance customer experience and operational efficiency.
- Long-term Growth Strategy: The increased capital expenditure reflects the company's commitment to a long-term growth strategy. By investing in infrastructure and expansion now, Krispy Kreme is laying the groundwork for sustained growth and market penetration in the future.
On the subject of McDonald's, the company was optimistic; we are less so:
- Potential Expanded Partnership with McDonald's: Krispy Kreme is discussing the possibility of expanding its partnership with McDonald's in the U.S. This expansion is seen as a significant opportunity.
- Pilot Program Insights - limited opportunity: The insights from the pilot program with McDonald's in Kentucky were mentioned, but it is a limited set of DNUT products. This pilot has been a critical part of ongoing analysis and discussions with McDonald's, focusing on operational execution, ensuring the right quality and timing of doughnut deliveries, and understanding the requirements for scaling beyond Kentucky. I don't understand the benefits that will accrue to MCD.
- Similarity to DFD Doors: The pilot program showed that McDonald's outlets behave similarly to Krispy Kreme's Direct-to-Store Delivery (DFD) doors regarding sales and customer reception. Both loose and pre-packed doughnuts were well-received in these outlets.
- No Cannibalization of Base Business: The expansion into QSR (Quick Service Restaurants) outlets like McDonald's does not seem to cannibalize Krispy Kreme's base business in other DFD doors or retail locations.
- Investment in Manufacturing Capacity: Classic MCD move - "If you want our business, you need to spend more money without a guaranteed return!" There is a plan to thoughtfully start making additional investments in manufacturing capacity to support this scale of growth, indicating confidence in the potential of this expanded partnership. The company expressed excitement and confidence in the potential of this partnership, seeing it as a substantiation of the Krispy Kreme brand as they scale it.
Why DNUT is not exposed to GLP-1
- Consumer Trends Unaffected: It was noted that the trends in Krispy Kreme's consumer base remain strong, and there has been no observed impact from using these drugs.
- Nature of Purchases: Most of Krispy Kreme's sales are for sharing sizes and special occasions, suggesting that their products are often purchased for group consumption rather than individual use.
- Infrequent Purchase Pattern: Individual consumers typically buy Krispy Kreme less than three times a year, indicating that it's more of a treat than a regular dietary choice.
- Caloric Content: A significant portion of Krispy Kreme's sales comes from under 200 calories each donuts, which may mitigate health concerns.
- Primary Purchase Barrier: Accessibility and availability remain the primary barriers to purchase, not health considerations. Health concerns are a low priority for their customers and have not changed significantly in recent surveys.
KRUS Conference Call Summary
Kura Sushi (KRUS) 4Q23 Non-GAAP EPS of 0.25 beats by 0.01 and Revenue of 54.9M (+30.7% Y/Y) misses by 0.7M. Kura Sushi reported an impressive comparable sales (comps) growth of 9.5%, surpassing the FactSet estimate of 7.8%, but sales slowed significantly in October. Also, the RLM stood at 21.9%, slightly below the FactSet projection of 23.3%.
Key Highlights Summary
- Record-Breaking Performance: Closed a record-breaking year with a strong fiscal fourth quarter. Full-year restaurant-level operating profit margins improved by 70 basis points to 21.9%.
- Growth and Expansion: Achieved a record of 10 new unit openings. Average Unit Volume (AUV) increased from 3.8 million to 4.3 million. Adjusted EBITDA grew significantly from 9.2 million to 14.3 million, a 56% increase.
- Sales and Traffic: Total sales for the fiscal fourth quarter were 54.9 million, with a 6.5% comparable sales growth. Traffic growth contributed significantly to this increase—continued strong sales performance with branded comps for September and October at 2.7%.
- Cost Management: Improvement in commodity costs with the cost of goods sold at 29.5%. Labor costs held steady at 28.8%.
- Operational Efficiency: Restaurant-level operating profit margins reached an all-time high of 24.4%. We opened four new restaurants in the fiscal fourth quarter.
- Technological and Marketing Initiatives: Launched a new reward program app with a positive guest response. Development of robotic dishwashers progressing, with implementation expected in spring 2024.
- Brand Collaborations: Successful collaboration with Jujutsu Kaisen and a strong pipeline for future collaborations.
