Papa John's: Still an Appetizing Stock

| About: Papa John's (PZZA)
On Thursday Burger King (BKC) sealed the deal and agreed to be acquired by 3G Capital Management, a private equity firm, for $24 a share. This $24 price equates to an Enterprise Value to EBITDA (EV/EBITDA) multiple of 8.8 and is in line with the historical acquisition valuations assigned to high quality restaurant companies. Restaurant stocks across the board rallied on the news. In particular, I think Papa John’s (NASDAQ:PZZA) is undervalued and offers significant appreciation potential.
Back on March 22 of this year Seeking Alpha asked me for my “High Conviction Stock Pick”. I indicated Papa John’s. My rationale at the time was Papa John’s is very well managed, has a good business model and is significantly undervalued. My opinion on this company and stock remains unchanged. I think investors can buy the stock at today’s price and still do well over time.
In my interview on March 22, I indicated high quality restaurant stocks were generally acquired at EV/EBITDA multiple of nine. Interestingly, this is in line with what the multiple being applied to Burger King. While it is unlikely Papa John’s will be acquired, I think it is still significantly undervalued and has a high probability of delivering market beating returns. Below is a chart comparing Papa John’s stock price against its valuation (EV/EBITDA) since February 1996:
You will notice in 2006 and 2008 the valuation of the company peaked at an EV/EBITDA multiple around 11.5. At the market bottoms in 2003 and 2009 the company traded towards an EV/EBITDA multiple of 5.0. (Prior to 2000, in my opinion Papa John’s was an overvalued growth stock. I stay away from these types of stocks. They can be hazardous to your wealth!) Using an EV/EBITDA multiple of 5.0 on the downside and 9.0 on the upside, I still think the upside appreciation for Papa John’s far exceeds the downside risk. Let us do the math. If we were to assign a 5.0 EV/EBITDA multiple, we get a stock price of $20.40. If we were to assign an EV/EBITDA multiple of 9.0 to the stock, we get a stock price of $38.85. My estimate of Papa John’s upside potential is about 2.9 times my estimate of its downside risk.
In addition to a favorable valuation, a secondary factor associated with Papa John’s is the fact that over time its intrinsic value has grown. As I indicated in the March interview, much of this growth can attributed to well timed stock repurchases. I actually love to own companies where the actual business growth is low but management has the discipline to reduce the size of the business via stock purchases or debt repayments. It has been my experience that buying undervalued companies combined with management that understands how to allocate capital can create some wonderful investment results.
To illustrate, below is a chart that displays Papa John’s Normalized Intrinsic Value versus its stock price since 1996. (Note: Normalized Intrinsic Value is calculated by normalizing EBITDA margins over the course of time and applying an EV/EBITDA multiple of 9.0 to Papa John’s stock.)
You will notice in the chart above that the company’s normalized intrinsic value has grown steadily over time. You will also notice that over time Papa John’s stock price has followed its intrinsic value. What is interesting is that, as the table below illustrates, sales and EBITDA have grown much less than its stock price.

Change from September 2000 to September 2010
Sales Growth 31.5%
EBITDA Growth 13.5%
Shares Outstanding -46.5%
Stock Price Change 52.5%
Normalized Intrinsic Value Change 181.1%
The appreciation in Papa John’s stock price and growth in Normalized Intrinsic Value over time has been aided by the reduction of shares outstanding.In an environment where I think the economy is going to exhibit anemic growth over the next decade, it is important to look for companies that are undervalued, have a good business model and are managed well. Papa John’s meets this ‘trifecta’ of criteria. Hence, I think it is highly likely investors in Papa John’s will make money over the next five years and it is unlikely they will suffer indigestion.

Disclosure: The author and clients of Granite Value Capital are long PZZA.

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