Description

Papa John – Cash Flow Play

This is not a particularly brilliant or exceptional idea especially since it was written up several dollars earlier and at that time I thought $30 would represent full value but everyone is entitled to a change of mind. Besides, I like it.

Papa John currently runs 593 company and 2149 franchised restaurants in the United States. There are a number of units overseas, especially in England (another 2 company and 181 franchise), but these haven’t added much to profitability and thus can be safely ignored.

At $29, the market cap is 659 million. The year end (12/30) BS shows 17m in cash and 192m in total liabilities. Long Term Debt stands at 105m. Take the difference and a conservative enterprise value is 834m on the high end to 764m. Trailing income is 47.2m, with 35.2m in d/a, for 82m in cash flow.

Here is why I like the stock:

- Cash flow. Paying 764 to 834m for 82m in cash flow seems pretty cheap in a world where 30 year treasuries yield about 5.7%. CapEx is estimated at 38m in 02, so a good part of that cash flow is free cash flow. CapEx will likely be in a range of 35-40m barring some unlikely event for the next few years per the company.

- Option grants for 01 and 00 were more than reasonable. In the words of the CFO, the days of 1m share grants are over. In 00 197,000 grants were dolled out, with 207,000 last year. This compares to 22m shares outstanding. Thus, your purchase isn’t going to get seriously diluted from you.

- Share buybacks. PZZA has used 217m in the past 3 years to buy back shares. Sure, they went into debt to do it, but the buybacks represent management at its rational best in my opinion. PZZA recognized operational issues with their growth strategy (translation – some new areas stunk) and thus put a halt to expansion. How many former growth stock managements are going to do that? And because they think making pizza is the thing they should do, management didn’t go out and acquire a hospital chain or energy trading company or anything like that. Instead, they bot shares. Plus, they have since purchased another 1m shares in the 1st quarter. The company is currently comfortable with an upper limit of 150m in LTD.

- Comps get easier. Same store sales have been dismal in the past year but March saw the first positive number for both company and franchise units in the past year despite the timing of Easter. Thus, wretched sales make for easier comparisons starting in April.

- The Product. Just a personal opinion (backed up by numerous awards), but I think the company makes a good product and retains some limited loyalty in its client base. Thus, there is no reason to think that business is going into the toilet anytime soon, especially with the company’s one product focus.

- Relative Valuation. I know this is a no-no for some folks but among the better known restaurants (APPB, EAT, CAKE, CEC, OSI, RYAN, etc.) PZZA's valuation is on the low end. I’m not really sure why.

- Insiders own a Lot. More than 34%, with founder and CEO Schnatter more than 28%.

What I don’t like about this company:

- this ain’t no growth stock. Of course, that hasn’t seemed to matter lately (see the miraculous increase in RYAN in the past year for proof of that). Company units are actually down so far this year, so expect no growth there. The company would like to see franchises re-accelerate unit growth to a higher level but that isn’t going to happen in 2002. If the price moves much higher the buyback will begin to make less sense.

- special charges disease. PZZA has had its share of charges in the past few years, including some asset write-downs, franchise loan receivable write-offs, and some goofy litigation brought forth by a Pizza Hut. The litigation appears dead for now, though the trend in write-offs is worth watching as it is a clear indicator of the health of part of the franchise base. There’s no way to predict such things so that’s why I didn’t give PZZA any credit for other assets on the balance sheet.

- this is a Pizza chain. Competition is the norm with this industry, and pizza alternatives at Supermarkets or eat-in buffett’s for $4 doesn’t help matters. This seems to be factored into the price.

A number of other things could go right for this company, including improving cheese and labor costs, though those are all wild cards. If you consider this idea also read the interesting previous write-up.

Catalyst

Easier Comps Start April