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Does Papa John's Growth Justify Its Valuation?

By Michael Lewis – Mar 4, 2014 at 12:00PM

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With huge growth opportunities abroad, Papa John's should have no problem keeping the top and bottom lines growing comfortably. The thing is, the market may have already priced in the growth.

One of the pizza delivery industry's leading players, Papa John's International (PZZA 0.03%), continues to grow on all levels -- sales, income, store count, and even margins. The company is outpacing its larger rivals here in the United States with very attractive same-store sales growth. Papa John's value to shareholders lies largely in its international prospects, similar to peers' strategies, though there remain compelling elements at home to keep sales driving higher and higher. The biggest question for investors is whether the rich valuation allows for substantial capital appreciation in the future or if this high-growth story is already baked into the stock price.

Slingin' slices
Similar to its next biggest rival, Domino's (DPZ 0.34%), Papa John's posted great international store sales figures  -- up 7% in the recently ended quarter. Surprisingly, in North America the numbers were even greater at 9%. The reason for such high domestic sales was encouraging -- a plain and simple jump in comparable sales, mainly at Papa John's' company-owned stores. The company's domestic comparable sales climbed more than 11% in the fourth quarter.

On the bottom line, Papa John's grew adjusted net income by more than 30% to $0.41 per share.

As mentioned, the big story here is international growth. Papa John's just hit its 1,000th international location -- a fraction of the size of Domino's near 6,000 locations. The company is targeting long-term international store sales growth of 5% to 7%, similar to Domino's' plans and the industry at large. In the coming year, it expects 220 to 250 net new stores, with the lion's share opening abroad.

How does it stack up?
Papa John's and Domino's have very similar businesses in terms of margins and growth prospects. Both companies are also relatively richly valued, with Papa John's the richest by price to earnings -- more than 25 times. The industry tailwinds are strong and growth is guaranteed, but downside risk is substantial if the international strategy hits a few bumps in the road.

Investors should keep an eye on a few things for Papa John's. Obviously, the new store openings need to yield a high ROIC, or at least within the range of projected same-store sales growth. If the stores opened for more than one year aren't hitting the 5% mark, investors are paying a pricey premium for the strategy. On the domestic front, the largely fractured pizzeria market lends itself well to the corporate chains. With 40% of U.S. pizza sales sourced from independent businesses, Papa John's and its corporate brethren have a large opportunity to take on more market share and grow sales even though the domestic pizza market is quite mature.

All in all, Papa John's remains an attractive growth stock with significant potential for capital appreciation, though there is plenty of downside risk. Investors should be encouraged by recent store-level sales and forward guidance on both the domestic and International front. By virtue of being a smaller business than Domino's and industry juggernaut Yum! Brands, Papa John's holds the longest growth runway and thus the greatest potential for long-term gains in the delivery pizza business.

Michael Lewis has no position in any stocks mentioned. The Motley Fool owns shares of Papa John's International. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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