Papa John's Continues To Disappoint The Public

Overview

Papa John's Pizza (NASDAQ: PZZA) released its fourth-quarter 2018 earnings and revenue projections on February 26, 2019. Despite missing earnings and disappointing results, shares of Papa John's ticked up 3.5% in the extended session that same day with current share prices hovering around the $44 mark.

To summarize the company's Q4 2018 results:

$0.15 EPS. (Below average analyst estimate of $0.17 EPS). $374 million in revenue. (Below average analyst estimate of $392 million). Q4 net loss of $16.2 million. (Equivalently $0.44 per share).

The fact that demand for this stock is increasing after such disappointing earnings is questionable considering that the $374 million in revenue was a 20% year-over-year decrease from prior year's revenue of $467.6 million. Additionally, in the same period a year prior, Papa John's actually reported a net income of $28.5 million, versus the current posted results reporting a net loss of $16.2 million. Poor earnings coupled with a vast array of organizational issues stemming from a disastrous PR problem spell trouble for the pizza giant and has investors questioning whether the business' model has essentially rendered itself useless.

Source: Democrat & Chronicle

Starboard to the Rescue?

A few weeks prior to the earnings announcement, hedge fund Starboard Value indicated it was investing $200 million into the struggling pizza company with the potential of another $50 million invested by March 29. Following this, Papa John's named Starboard Value CEO Jeffrey Smith as the company's new chairman.

The move was applauded by current CEO Steve Ritchie who stated, "(We) are confident in the great growth potential for the brand, particularly with the support of our new partners." Ritchie has also theorized that Starboard's expertise, experience, and financial resources will complement Papa John's expanded menu and new advertising strategy.

The hedge fund is no stranger to taking on activist roles at companies in order to boost growth. Starboard has worked with over 50 undervalued companies and has actually a posted a fairly good record in delivering shareholder value through its activist interventions. Despite their record, Starboard will have to perform the unthinkable if they want to turn Papa John's around.

A Plethora of Headwinds on the Horizon

A key alarming figure under-reported by the pizza company was that North American comparable-store sales declined 8.1%, representing a decrease in annual sales for the first time in 9 years. Sure, one may deflect this towards the fact that pizza sales in general across North America have recently stagnated as evidenced by disappointing results from industry leaders such as Domino's Pizza (NASDAQ: DPZ). However, in the case of Papa John's, the company faces much deeper underlying issues that have been eating away at the company's growth prospects for many years now. What Papa John's has is a major PR problem, which is arguably one of the hardest issues a public company can resolve.

This initially started with former CEO and Founder John Schnatter, who still haunts the company to this day. Papa John's relationship with the NFL originally paid tremendous dividends for the pizza chain, but after the NFL fell into hot water after protests from players, Papa John's sales quickly dropped. Schnatter blasted NFL Commissioner Roger Goodell for his mishandling of players kneeling during the national anthem and blamed the league for the company's struggles. However, Schnatter further exacerbated the problem by apparently using a racial slur during a conference call, an action unacceptable by any standard and the reason why the company's reputation and loyalty has reached a level beyond repair.

Ultimately, Papa John's ended its relationship with the National Football League and has since parted ways with the troubled John Schnatter. Unfortunately for the Papa John's, Schnatter still owns about 30% of the company and continues to meddle with business decisions, a clear example being his own proposed investment that he ended up backing out of after accepting Starboard's position. If Papa John's wants to revive their brand and win customers back, they must fully part ways with John Schnatter and get him out of the picture. Schnatter's relentless and outspoken personality prove that this is much easier said than done.

Source: Investor's Business Daily

Market competition from Domino's Pizza, Pizza Hut (NYSE: YUM), and Little Caesar's will crowd out any effort of recovery from Papa John's, especially in a stagnating market fiercely competing for market share. These top 3 pizza chains control a large majority of existing market share, and with supply chains and marketing strategies far more sophisticated than the capabilities that Papa John's possesses, they will continue to dominate winning consumers over to buy pizza from their franchises.

In the pizza industry, delivery service is perhaps the most paramount advantage one can have over its competitors. When people think delivery, they generally think of Domino's Pizza first. This is no coincidence, Domino's has been at the forefront of innovation in its services for many years now, and was the company behind the viral video of a self-driving delivery vehicle delivering pizza to a customer. This itself wasn't even a novelty, as evidenced by the company unveiling a customer delivery vehicle with a built-in heating oven back in 2015. The pizza leader is now in the testing phase of drone and robot delivery, a feature other companies in the pizza industry can't boast about. The creation of new technology and engaging, forward-thinking advertising is the reason why Domino's controls 30% of the pizza delivery market. Domino's also possesses a sophisticated database system hailed as a "competitive advantage" by Stifel (NYSE: SF) analyst Chris O'Cull. This not only helps with the collection of data for valuable consumer insights and customer retention through loyalty rewards programs, but also assists franchisees in keeping their overhead costs down by having a majority of orders cultivated digitally through it's custom operating system.

Source: CBC

Analysis & Verdict

Any financial analyst will tell investors to stay clear of this stock for time being. With adjusted earnings of $1.20 per share, investors are trading shares around 36X forward earnings. A darker picture is painted upon examination of GAAP earnings-per-share guidance which currently stands between $0.00 and $0.50 for 2019. Earnings will continue to disappoint as Starboard and Papa John's realize they will need to inject more capital into reviving the brand. This analysis coupled with the fundamental analysis mentioned earlier illustrates a stock that is overvalued and expensive for investors looking for a share of the company. The final verdict for Papa John's is that although there is potential with Starboard Value taking an activist role within the company, there is an extremely high probability and exorbitant amount of risk that this potential will never materialize. Take a short position in Papa John's for an easy profit, I expect this stock to decline to a value between $30 to $40 by year end, with greater room for a further downtrend going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.