The Pizza Wars: Domino's Vs. Papa John's

Includes: DPZ, PZZA
by: Ron Sommer

Only in America. Only in America can an ethnic food become a staple of our diet. Pizza is one of those foods that have made the transition from an immigrant group to being a favorite of all people. In New York family-owned and operated pizza joints are as common as traffic lights and competition is fierce. And yet, there is room in the market for national chains such as Domino's Pizza (DPZ) and Papa John's International (PZZA). The companies are similar in that they both operate internationally and both operate company-owned and franchised stores. They are roughly comparable in sales volume and gross margins.

Domino's has a network of 9,900 company-owned and franchise stores operating in all 50 states and in more than 70 international markets. Domino's reported 2Q12 EPS of $0.47, up 17.5% Y-o-Y on revenues of $376.1 million. Revenue was down Y-o-Y by 2.3% from $384.9 million. EPS for the TTM ending June is $1.70, up 14.1%. Sales grew more modestly at 2.3%.

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Second quarter EPS beat analyst expectations though we note that actual EPS for 1Q12 were below expectations. The worldwide macroeconomic environment hurts all companies with operations around the world. Growth has slowed considerably in China and the world's largest economy, Europe, is in turmoil. The company suffered from currency fluctuations but managed to grow same-store revenues and international unit growth.

The company has about $10.8 million in cash and short-term investments and about $1,548.6 million in long-term debt. Times Interest Earned is a slim 2.6X. In the fiscal year ending January 2012, the company reported free cash flow of $2.09 per share. We estimate free cash flow to have increased to $2.52/share. The company does not pay a dividend but it has repurchased 1,146.497 shares at a cost of $36.9 million at an average cost of about $32 per share.

Management provides guidance for domestic same-store sales growth in the 1.0% to 3.0% range. Goldman Sachs recently upgraded DPZ to a "Buy" and increased its price target to $40 from $34.

Based on Papa John's 1Q12 report, the company operates 3,883 restaurants, of which 628 are company owned in all 50 states, Columbia and Puerto Rico and in 33 countries. For the period ending 3/25/12, PZZA reported EPS of $0.69 compared to $0.64 in the year-ago period. This beat Street estimates by $0.14. For the same period, revenues increased by $18.8 million to $331.3 million from $312.5 million. For the twelve month period ending in March 2012, EPS declined 13.1% to $2.25 while sales declined by 14.0% to $1,236.7 million. The company also beat analyst forecasts for 4Q11.

Papa John's has $45.1 million in cash and short-term investments and $50.0 million in long-term debt. Times Interest Earned is 73.2X compared to DPZ's low coverage. Long-term debt, at $50 million is less than our estimate for free cash flow, $87.6 million. PZZA does not pay a dividend but it does buy back shares. Most recently, it bought back about 5.6% of its shares,

KeyBanc capital Markets recently initiated coverage with a "Buy" rating and a target price of $58. The positives for PZZA are that the shareholder is benefiting from growth, share buybacks and solid free cash flow. The company also continues to see a net increase in restaurants operating worldwide and growth in same store sales.

The company provides guidance for the year for diluted earnings in the $2.40 to $2.50 range on 6.0% to 7.0% revenue growth.


The negatives for Domino's outweigh the positives. The company has negative shareholder's equity and the company's valuation metrics are unappealing. We think Papa John's is the better investment. The company appears to be undervalued while showing signs of continuing growth. The company also has a free cash flow yield of about 7.0%. Share buybacks are supported by ample free cash flow and forecast earnings growth looks good. With a history of positive earnings surprises, PZZA may have a way to go yet.

Disclosure: I am long PZZA.