Rating: Maintain at Buy
We continue to love both of these pizza companies in Papa John's and Domino's. Both continue to create a lot of equity value right now through their expansion overseas and good value for customers. We are still in a market where consumers remain cost cautious, and PZZA/DPZ both appeal to consumers to get a good deal on meals for affordable prices that we believe is allowing them to see good domestic sales. Both have seen great growth overseas with Papa John's outperforming Domino's for growth domestically. PZZA grew about 6% in sales in the latest quarter, which is a very strong growth rate for fast/casual dining firms especially in a highly competitive pizza industry. We upped our price target on PZZA due to outperformance of expectations. We upped our operating income targets for the year from $95M to $105M as the company raised guidance and beat our expectations. Further, the firm continues to manage to have very low beta, low debt, and low capex, which continues to add a lot of equity value. Not to mention, that PZZA spreads their value across only 22M shares, which allows for good premium. DPZ, much like PZZA, is seeing excellent international expansion. Dominos drastically beat our expectations for the company, and we increased our expectations for the year by 10%. The reason was mostly due to margin increase as DPZ is not improving at the same rate as PZZA. The company is seeing great margin expansion with gross margin all the way to 30%. That margin is extremely strong, and if it can maintain over 25% for the next year, this stock is very cheap right now with a future PE at an estimated 15. Both companies right now are showing great performance in overseas markets that should continue as pizza is just starting to take off in places like China, Brazil, and India. We do prefer PZZA over DPZ due to its more sustained growth in actual sales. Its growth is very similar to reasons we like Yum! Brands (YUM) for their current growth in new markets.
We believe both companies will continue to offer solid growth throughout the end of the year. The NFL season is just around the corner as well as continued international expansion. Both will provide nice catalysts moving through the end of the year.
PZZA upped its guidance for the rest of the year, but DPZ did not provide any. The previous guidance was for EPS of 2.40 - 2.50, which was increased to 2.45 - 2.55. The company also sees same-store sales in North America increasing 2%-3% now for the year versus 1.5%-2.5%. International sales are expected to be better as well.
Margins have increased for both companies. Operating margins are a bit stronger for DPZ, but both companies are seeing improving profitability at this point. DPZ's growth is not as strong as PZZA, but its margins are much better. Overall, both are seeing improving profitability in the wake of a lot of food price increases. Cheese prices have been lower, but many other inputs are increasing. As long as margins stay strong, these companies should continue margin expansion.
We like the value of both companies right now for more upside as both companies are growing at strong rates, improving profitability, and have very good potential to maintain this path right now with seasonal strength.
In the Fast/Casual Dining industry, DPZ and PZZA ranked 8th and 10th out of 12. Both companies are definitely growing at a slower rate than some of their competitors like Chipotle (CMG), Panera (PNRA), and Starbucks (SBUX), but their overall capacity to grow at those rates does not exist. What these companies are doing is seeing very good growth without much of an economic moat in a tough pizza industry. That shows us great execution, effective marketing, and decent product support/loyalty.
Both companies have decent financial health but are not at risk. A 0.5 quick ratio and 1.0 current ratio are what we look for as minimums for good health. DPZ and PZZA ranked 6th and 9th, respectively, out of 12 for financial health in the industry. Neither company should be bought for that strength, but debt is low for both. We would love to see FCF improve for both companies as well.