"High cheese prices" have been a fixture of earnings releases and annual reports for Hidden Gems watchlist stock Papa John's (NASDAQ:PZZA) for years. They've been blamed for everything from earnings misses to declining profit margins to that bad case of heartburn you got after last year's Super Bowl game. But just as every pizza has two sides, the tasty one and the -- No! Wait, don't flip it over!
Sigh. Yes, and the side you never look at (and now you see why it's best not to try).
Anyway, the other side to the high cost of cheese, paid for by pizza makers such as Papa John's, direct competitors Domino's (NYSE:DPZ) and Yum! Brands' (NYSE:YUM) Pizza Hut, and indirect competitors such as California Pizza (NASDAQ:CPKI) and Chuck E. Cheese's CEC Entertainment (NYSE:CEC), is that whoever these pie magnates are buying their cheese from is probably making a killing. Yesterday, I stumbled across the name of one beneficiary of the inflated price of mozzarella, Lucille Farms (NASDAQ:LUCY), when it reported its first fiscal quarter earnings for 2005 -- and the market went wild.
The report looked like a flashback to my story on Nucor (NYSE:NUE) from months ago. You remember, the "double decuple" one. Lucille fell just short of Nucor's achievement, increasing its own earnings by a whopping 15 times: from $0.01 a year ago to $0.15 per share this quarter. And it did that on the back of a sales increase that increased "just" 53%. The rising cost of cheese -- up nearly 70% year on year -- helped boost the company's margins, and its per-share results also got a boost from share buybacks of 4.5% of Lucille's stock.
These results apparently took Wall Street by surprise, as evidenced by the meteoric leap that Lucille's stock price took on the earnings news (up more than 41% yesterday). But in its surprise, Wall Street apparently forgot why it had priced Lucille so cheaply in the first place. The company carries a considerable debt load and has an additional large chunk of debt masquerading as convertible preferred stock. More important, although Lucille was free cash flow-positive this quarter (recording a penny and a half of free cash flow per share), this is the first quarter since June of last year that it has been so. Moreover, the company has had negative free cash flow for two of the past three years. Day traders beware: This is an investment that could quickly turn sour.
Fool contributor Rich Smith owns no shares of any company mentioned in this article, although he has owned PZZA in the past.
