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Papa John’s (PZZA) Plagued by Declining Comps & High Costs


Papa John’s International, Inc. PZZA has been grappling with declining sales for quite some time. Soft consumer demand in the U.S. restaurant space has resulted in constant deceleration of comps, whereas high costs associated with restaurant operations have been potential headwinds for the company.

Recently, the company posted mixed fourth-quarter 2017 results, wherein earnings missed the Zacks Consensus Estimate while revenues beat the same. Adjusted earnings of 65 cents per share missed the consensus estimate of 68 cents by 4.4%. The bottom line also fell 6% from the year-ago quarter due to weak operating results.

Moreover, shares of Papa John’s have lost 19.4% in the past year against 15.4% growth recorded by the industry. With this unfavorable trend, earnings estimates for 2018 have been revised downward by 10.1% over the past 30 days, reflecting analysts’ concern surrounding the stock.

Difficult Sales Environment Results in Declining Comps

Over the past few quarters, comps growth in restaurants has been dull, traffic has been weak, and Papa John’s is not exempted from this challenging scenario.

In the fourth quarter of 2017, domestic company-owned restaurant comps declined 4.7% against comps growth of 4.8% in the year-ago quarter. Comps for North America franchise restaurants fell 3.5%, comparing unfavorably with comps growth of 3.4% in the fourth quarter of 2016.

The company expects North America comps in the range of negative 3% to flat in 2018 and anticipates continued pressure in domestic sales.

Higher Expenses Remain a Challenge

Papa John’s is plagued with high costs associated with restaurant operations. Costs related to marketing initiatives, unit expansion, digital ordering, and increasing use of online and mobile web technology is keeping the company’s profits under pressure. Moreover, the company is also shouldering higher labor costs due to the implementation of The Affordable Care Act, commonly known as Obamacare that is expected to have an adverse impact on margins, going forward.

In the fourth quarter, total costs and expenses amounted to $429.3 million, up 7.8% from the prior-year quarter. Total operating margin was 7.8%, a decrease of 390 basis points (bps) year over year.

Expansion & Franchising Aids

Many of Papa John’s restaurants are located in international markets like Europe, the Middle East, Latin America and China, continuing to perform strongly. The China region continues to experience solid growth, driven by optimization of the company’s restaurant model, brand design enhancements and increased integration with third-party aggregators that is broadening its accessibility channels. Papa John's has inked developmental agreements in many regions including Mexico, Egypt, Russia, Spain, Chile, the Netherlands, Colombia and Boston. It also debuted in France and Israel in the past year and Morocco in 2017. Meanwhile, the company plans to open five units in Bahamas by 2021.

Notably, the company is committed to develop and maintain a strong franchise system. Management is continually striving to eliminate barriers to expansion in existing international markets and identify new market opportunities. Except for 35 company-owned restaurants in Beijing and North China, all of Papa John’s international restaurants are currently franchised. Over the next several years, the company plans to increase its international units, a large part of which will be franchised.

We believe, re-franchising a large chunk of its system reduces the company’s capital requirements and facilitates earnings per share growth and ROE expansion. Alongside, free cash flow continues to grow, allowing reinvestment to increase brand recognition and shareholders’ return. Moreover, since a major portion of its business is re-franchised, Papa John’s is less affected by inflation than its peers.

Zacks Rank & Stocks to Consider

Papa John’s carries a Zacks Rank #4 (Sell).

A few better-ranked stocks in the same space include BJ’s Restaurants BJRI, Darden DRI and Ruth's Hospitality Group RUTH, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

BJ’s, Darden and Ruth's Hospitality’s earnings for 2018 are expected to grow 27.7%, 18.4% and 20.9%, respectively.

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