Is Papa John’s Immune to U.S. Food Inflation?

Pizza Hut, the subsidiary of Yum! Brands (NYSE: YUM  ) (NYSE: YUM  ) , Domino's Pizza (NYSE: DPZ  ) , and Papa John's International  (NASDAQ: PZZA  ) are among the largest restaurant chains in the world. These food giants, especially Domino's and Papa John's, have grown substantially in the last year or so. However, rising food prices in the U.S. could hamper these food chains' profits this year. Now, the question is will this rise in food inflation affect all of these pizza chains similarly?

Quarterly earnings
On May 6, Papa John's released its first-quarter earnings. Same-store sales in North America jumped 9.6% while international comps rose by 6.4%. This was only the second time since 2011 when the company's North American comparable sales outpaced those at international locations. Revenue grew 12.9% to $401 million compared to $356 million in the year-ago period. The company earned $0.45 per share, 7% more than its year-ago earnings per share of $0.42.

In the domestic market, the company's sales were largely driven by its Double Cheeseburger Pizza promotion, which included an ad featuring Peyton Manning and four-time winning Super Bowl quarterback Joe Montana. Though the Double Cheeseburger Pizza was rather expensive, it did really well, which shows that customers are willing to pay more for quality pizzas.

As for the international division, Papa John's achieved system-wide sales growth of 22% and opened 17 net new restaurants. The company's focus remains on China with its growing consumer class and economy, which continues to grow at a more than 7% annual rate. Currently, the restaurant chain has only one restaurant for every 3 million people in the international market. Hence, it still has a lot of room to grow internationally.

Going forward
Lately, Papa John's launched a campaign with Indiana Pacers all-star forward Paul George to promote its new Sweet Chili Chicken Pizza. Given the fact that Peyton and Joe have proven to be great brand ambassadors for Papa John's, the company plans to use more athletes in its promotional activities.

Bloomberg noticed that since December, the prices of mozzarella cheese and cheddar cheese have climbed 16% and 25%, respectively, in the U.S. The U.S. Department of Agriculture, or USDA, expects the consumer price index, or CPI, to rise by 2.5%-3.5% this year. The highest price hikes will be seen in beef, veal, and poultry -- 3%-4% year-over-year. Due to intense competition in the U.S. restaurant industry, restaurants can't transfer these price hikes to the end consumer by increasing their retail prices. Therefore, the restaurant industry's margins will remain low this year.

Apart from selling pizzas, Papa John's also supplies restaurant equipment and ingredients like cheese, toppings, and dough to its franchises and company-owned stores. The supply chain business accounts for more than 40% of the company's total revenue. As commodity prices go up, the company's pizza business suffers but its supply chain business enjoys higher margins. On the whole, higher food prices will definitely have a negative effect on Papa John's but not a large effect, thanks to its supply chain operations. This is why the company is confident about achieving the lower end of its earnings guidance. 

Domino's Pizza and Yum! Brands
Like Papa John's, Domino's also has supply chain operations that contribute almost 56% of the company's total revenue. As commodity prices rose in the first quarter, the company's supply chain margin rose by 12%. Domino's continued to grow in the international market with strong comparable-sales growth of 7.4%. As a result of this success, the restaurant chain is spending heavily in India, Africa, Australia, and Japan. Domino's has provided a year-over-year capital return of 43%.

After facing poultry issues in China, Yum! Brands is finally showing signs of recovery. In the recent quarter, the company's comparable sales in the country rose 9%, which included comps growth of 11% at KFC and 8% at Pizza Hut Casual Dining. However, total Pizza Hut comps were down 2% due to lower pizza sales in the U.S. As food prices increase in the U.S., Pizza Hut's margins are bound to remain low this year.

Yum! expects a lot from its recently launched breakfast menu in the U.S., which mainly includes waffle tacos. Having said this, the company will face severe competition from McDonald's breakfast as McDonald's has done a great job there for the last few years.

Bottom line
In contrast with most of the pizza restaurants, which aren't posting encouraging results in the U.S., Papa John's comps data for the country shows that its pizzas remain quite popular with customers. In addition, the company's international comps are also growing at a fast pace. Owing to its supply chain business, which will mint more profit due to higher commodity prices this year, the company's earnings will keep growing. While this food inflation will surely affect Papa John's retail margins, its supply chain will offset this drop in margins to a large extent. Although the company's overall margins will shrink, it won't suffer like other restaurant companies will, which makes it one of the top buys in the industry.

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