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Why This Expensive Pizza Chain Could Be a Good Investment

By Yaggyaseni Mittra - Mar 13, 2014 at 6:51AM

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Growth in digital ordering and international expansion make this pizza chain an interesting proposition.

Pizza chain Papa John's International ( PZZA -0.62% ) posted pretty good results for the fourth quarter late last month, despite the fact that the economy is not in the best of health. It continues to grow with strong fundamentals and its strategy of "Better Ingredients. Better Pizza" seems to be working well as Papa John's is spending considerable time and money to ensure the highest quality standards.

As a result, it received the highest rating in the prestigious American Customer Satisfaction Index for the 12th time in the last 14 years. However, Papa John's is facing trouble in the Asian markets, such as China, where it is trying to make an impression. In comparison, its rival, Yum! Brands' ( YUM -1.34% ) Pizza Hut, has already established itself in the Chinese market . In the U.S. as well, Papa John's should keep an eye on Domino's Pizza ( DPZ -0.61% ), whose incredible growth in digital ordering can be a threat in the long run.

Strong growth
But despite such pressures, Papa John's is sailing quite smoothly. Its fourth quarter revenue increased 5.6% to $387.9 million. Net income rose to $18.8 million from $17.4 million last year. Last year, Papa John's had benefited from an extra week, which provided $21.5 million in additional revenue. Therefore, if we exclude the extra week from last year, Papa John's performance was even better in the previous quarter. Moreover, Papa John's systemwide comparable sales increased 9% for its North American business, and 7% in the international segment.  So, the company has seen good growth so far. But how does the future look?

The way forward
Papa John's main strength is its aim of providing the highest quality and service standards to its customers. It believes in the philosophy that "Satisfied customers lead to more loyal customers and loyal customers lead to more profitable franchisees who want to grow their business."

On the back of such a philosophy, Papa John's has grown to around 4,500 restaurants globally. It has opened 1,142 international restaurants in 35 countries by the end of 2013, and plans to open another 1,200 restaurants in the next six years. With such expansion plans in the pipeline, it is also spending on promotions for improving its brand image further.

Keeping this in mind, it has sponsored The Football League in the U.K.   and is also the official pizza sponsor of the NFL. It has also entered into a partnership  with Peyton Manning, and believes that this is another reason why it should continue seeing sales growth going forward as the quarterback is one of the most well-known faces in American football. This could be another sales driver since the NFL's Most Valuable Player commands a strong following and if he promotes Papa John's, he could bring more customers into the stores.

Technology investments and competition
Papa John's is also strengthening its position in digital ordering. In 2013, it became the first pizza chain to get more than 45% of its sales through the digital channel. Over the years, Papa John's has shown its digital leadership through various initiatives and it is continuing to do so going forward through a new point-of-sale system.

This will be important going forward as Domino's is also seeing good growth in online orders. Domino's digital sales account for more than 40% of domestic sales, while the company's global digital sales were around $3 billion last year. Domino's has bolstered its digital platform further and invested over $40 million last year to improve sales, with much of the investment made in technology.

Papa John's is also improving its production facilities through a fully automated dough production mechanism. This should increase the quality standards and uniformity of its offerings. Papa John's has also enhanced its product line with new offerings. It has added Buffalo Chicken Pizza to its menu, which won Nation's Restaurant News Menu Masters Award for the best limited-time offer pizza.  

However, Papa John's is facing tough competition from Pizza Hut in China. The Yum! Brands pizza chain has more than 1,000  Pizza Hut locations in China, which makes the entry of Papa John's in this market difficult. Yum! Brands saw 5% growth in same-store sales in China  for the Pizza Hut brand in the fourth quarter, with more gains expected going forward. However, Papa John's reputation of delivering quality can help it gain a foothold in this market, especially since Yum! Brands has been embroiled in bird flu and other quality troubles in China with its KFC chain.

Papa John's has a trailing P/E of 32.84, which is the highest among peers. But a forward P/E of 25.45 means that earnings growth is expected in the future.  Also, Papa John's isn't very expensive when compared to Domino's, which trades at a trailing P/E of 32, which means that it offers growth at a relatively fair valuation when compared to the industry.

Papa John's focus on maintaining high quality standards and service could help it crack foreign markets such as China, while investments in technology could bolster its digital business further. So, Papa John's could be a good buy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
$124.83 (-1.34%) $-1.70
Domino's Pizza, Inc. Stock Quote
Domino's Pizza, Inc.
$521.77 (-0.61%) $-3.23
Papa John's International, Inc. Stock Quote
Papa John's International, Inc.
$124.29 (-0.62%) $0.78

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