"Better ingredients, better pizza!" It is a slogan not only ingrained in the minds of pizza eaters, but according to the company's second-quarter earnings conference call it is also a part of the fabric that makes up the operational system for Papa John's (NASDAQ:PZZA). If you are looking at a snapshot of the company's latest performance, my Foolish colleague Jim Mueller has served up a nice look at its results, particularly in regard to its free cash flow situation.
In this latest Folly Volley roundtable discussion, we will take a closer look at the company's quality component, as well as its international opportunities, and what the combination of the two means for investors.
Better ingredients
Jeremy: Let's kick off with the question CEO Nigel Travis posed during the call: "How are we achieving this performance level in the face of a tough category and strong competition?" No doubt, the pizza industry has never been more crowded with competition. Domino's (NYSE:DPZ) and Pizza Hut, a division of Yum! Brands (NYSE:YUM) stand out, of course. Add in rising challenger California Pizza Kitchen (NASDAQ:CPKI), as well as a litany of entrenched local pizza makers around the world, and it is evident that success in this business is no easy feat. How has Papa John's pulled it off so far?
Bodhi: Travis highlighted a twin focus on quality ingredients and operational execution as the winning recipe. As evidence that the strategy is working, Travis pointed to the University of Michigan Business School's American Customer Satisfaction Index, in which Papa John's received the top spot for the seventh consecutive year, even edging out survey newcomer Starbucks (NASDAQ:SBUX). Better ingredients, better pizza!
Hank: Can you get any cheesier?
Jeremy: Who's cheesy? Break it down for us, Bodhi -- how do quality ingredients and operational execution actually play out in day-to-day business?
Bodhi: A part of its better-ingredients focus is product development. Customers have been willing to keep coming back to Papa John's to try out new options like a new dessert pizza, a King Kong-sized meat pizza, chicken fajita pizza, or its very successful Papa's Perfect Pan.
But the pie is only one part of the equation; getting the word out to pizza lovers is equally important. A revamped marketing campaign, a highlight of its operational execution, is also vitally important. This can mean an increase in its public relations spending and activities, but Papa John's is also employing other creative measures to get the word out on the street. For instance, a sponsorship arrangement with Six Flags (NYSE:SIX) -- where Papa John's now has 60 sites in 17 Six Flags locations -- is used as a means to tap into the 25 million annual theme park guests. Once a family is done whipping around roller coasters and heads for home, there is a good bet they will bump into one of 1,100 Papa John's located within a 150-mile radius of a Six Flags. That's smart advertising.
Better growth opportunities
Hank: Obviously, product development and sound advertising is critical, but let us not pretend that these will be the primary drivers of its top line in the years to come. Look no further than the guidance offered. For the year, it is looking for domestic comps of 3% to 5%, while it is projecting sales from its international units to increase 25% to 30% this year. China, India, Korea, Mexico, Russia -- these areas will be the key vehicles for growth over the next couple of decades.
Jeremy: On that note, Travis declared, "International as a whole offers us enormous future opportunities, but it will take plenty of hard work." We can add here that it will require some serious capital to build out an infrastructure needed to support such a global expansion.
Hank: That's true, just in terms of developing an efficient supply chain, making quality ingredients accessible and affordable to its international franchisees. We can already see the effects of these upfront investment costs. Through the first half of this fiscal year, its international efforts have resulted in an operating loss of $4.8 million. Expect this trend to continue as the company attempts to forge what management described as a "beachhead" in such markets as Mexico, the U.K., and China. Developing a new market takes time and money, but Papa John's leadership believes the payout tomorrow will be well worth the expense today.
Bodhi: OK, can we back up a bit? Look, international is key for Papa John's -- no one questions that. But Hank, I do not believe management was pretending when stating that its philosophy of quality and the systems supporting its benchmarks were the reasons for its success.
When speaking on the system that Papa John's founder John Schnatter helped inspire, I found Travis' remarks telling. He described the system that manages its quality control as "incredible," elaborating further, "If ever I left here and went anywhere else, I would take that system with me because it's simply the best system I've seen in any company."
These are strong words, and I believe it is this system -- built around quality -- that makes the company's expansion efforts, be they domestic or abroad, a successful reality.
Better quality + better opportunities = better investment
Jeremy: One journalist during the Q&A portion of the call raised the concern of an oversaturated pizza market, even suggesting that the category as a whole is contracting. Papa John's CEO Nigel Travis' response should be welcome news to shareholders, "There's certainly evidence to support that. But clearly, we've gone in the opposite direction."
Travis remains "very bullish," as evidenced by maintaining his company's long-term projection of 10% to 12% earnings-per-share growth, as well as through highlighting the substantial unit growth opportunities even in the seemingly saturated U.S. market. Domestically, management believes the market can hold another 1,500 units. Internationally? Well, lets just say the numbers are off the charts. As the company builds out the supply chain infrastructure necessary to support expansion overseas, there will be upfront costs. For patient shareholders, these initial costs will be viewed as a small bump in the rearview mirror on the road to a solid long-term investment.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.
