Americans buy a lot of pizza — approximately $38.5 billion worth in 2015 — and that got me thinking about former Fidelity Magellan portfolio manager Peter Lynch. One of the all-time great investors, he believed in investing in what you know and are familiar with. For most of us, pizza certainly meets this criterion.
There used to be a saying that it was better to invest in mutual fund companies than in the mutual funds those companies marketed to retail investors.
While it’s less true today with the advent of the exchange-traded fund, the rationale was you’d do a lot better riding the mutual fund wave than you would from the active management provided by the mutual fund managers of the funds themselves.
That same rationale can easily be applied to pizza. It’s not the healthiest food to shove down your throat but if you’re going to do it (I do at least once a week) you might want to place a side wager on your favorite pizza franchise.
Why?
Over the past five years Papa John’s Int’l, Inc. (PZZA) and Domino’s Pizza, Inc. (DPZ) have both delivered huge for their shareholders generating gains of 300% and 700% respectively compared to 46% for the S&P 500. If you invested $5,000 in DPZ stock on March 17, 2011 — my guesstimate of the amount spent on pizza over those five years — today you’d have over $37,000 — more than enough to pay for your pizza habit and then some.
So, if you regularly go to Domino’s, that might be the best stock for you. It’s your call. But for me the best stocks to own in the pizza space are:
Pizza Stock to Own: Papa John’s Int’l, Inc. (PZZA)
Papa John’s reported decent, if not great, Q4 earnings announcement Feb. 23. PZZA stock hasn’t been nice to investors so far this year as a result, up less than 1% year-to-date. But before investors throw the baby out with the bathwater it’s important to consider what lies ahead that could spur better results.
In a nutshell the company got caught with its pants down in Q4 as competitors beat them to the punch offering significant deals to take market share, and by the time it was able to react, the damage had been done. Its North American franchised outlets eked out a 1.3% same-store sales increase in the quarter while its domestic company-owned stores did slightly better up 3.4%. The best of the bunch, its international restaurants saw 5.3% same-store sales growth in Q4 and 6.9% for the entire fiscal 2015.
While it needs to get its same-store-sales growth engine moving again to drive PZZA stock higher, investors can latch on to two positives when it comes to the future strength of its stock.
First, while it might have had a hiccup in same-store sales growth in Q4, it definitely continues to make money and that’s what ultimately drives stock prices. In 2015, free cash flow was $121 million, 64% higher than in 2014. Despite the sales slowdown, Papa John’s free cash flow yield approaches 6%, almost double where it was at the end of 2014.
That’s a plus.
A second stat to hang your hat on is the company’s record for repurchasing shares. Between 2005 and 2013, it bought back shares whenever PZZA stock traded at less than its historical price-to-earnings multiple of 23.4 and then slowed down the buybacks after that when its P/E multiple floated into the 30s. I’m not sure if you could call CEO John Schnatter a modern day Henry Singleton, but his record appears to be better than most.
At the end of the day, PZZA stock will rise to the occasion soon enough because you know we’re not going to stop eating the product.
Pizza Stock to Own: Domino’s Pizza, Inc. (DPZ)
In light of DPZ stock dominating over the past few years, it’s only fitting that I move to Domino’s which seem to be continuing to light up the pizza industry with Q4 earnings results that were better than analyst expectations. Consensus Metrix suggests Domino’s U.S. franchised stores beat the analyst estimate for same-store sales by 440 basis points coming in at a very strong double-digit 10.7% while company-owned locations were up 10%, 430 basis points better than the analysts were expecting.
The top line was good, and so was the bottom — net income in Q4 2015 was $62.8 million, a 31% increase year-over-year — suggesting investors can expect good things to come in 2016 and beyond.
While the U.S. market is rock solid, it’s the international business that holds the key to future growth. Pizza delivery outside North America isn’t nearly as established and so it’s the master franchisees the company has selected in other countries to carry the Domino’s flag that will have to deliver the goods.
At the end of 2015 there were 7,330 international franchise stores that generated $164 million in revenue or 7% of Domino’s overall numbers. Its top three countries: India with 989 stores, the U.K. at 868 and Mexico with 622. This past year, Domino’s international segment opened 768 net new stores which represents 85% of the net new stores opened globally including the U.S.
The beauty of this setup is that despite the international segment generating 7% of its $2.2 billion in revenue in 2015, it was responsible for 32% of the overall income from operations. Better still, while the domestic business had capital expenditures of approximately $34 million, the international segment had none.
Do the math. Each international store on average generated $17,735 in operating profit in 2015. If they add 800 stores in 2016, that’s a potential increase of $14.2 million in operating profit without spending a whole lot of money.
There are risks in this model, but if done well, it can continue to be very lucrative. And while you might quibble with its valuation at 38 times earnings, you can’t argue with its success. DPZ stock is definitely a worthy contender.
Pizza Stock to Own: Yum! Brands, Inc. (YUM)
Our final option — Yum! Brands, Inc. (YUM), the conglomerate of greasy food — is having a good year compared to its restaurant-industry peers; its stock is up 8.8% year-to-date while the industry is up just 3.4%.
What’s its secret? A diversified menu.
In early February, it released Q4 earnings and Pizza Hut had the worst results with 1% same-store sales growth compared to 3% at KFC and 5% for Taco Bell. In this conglomeration of food, Pizza Hut doesn’t have to be the star performer 100% of the time — and that’s a good thing.
The pizza division isn’t exactly lighting it up at the moment — especially in China where it saw a 5% same-store sales decline in 2015 — but CEO Greg Creed is confident the division can get its mojo back.
“I’m very encouraged by the start of 2016 for Pizza Hut,” Creed said on its Feb. 4 earnings call. “I have confidence that you will see us deliver sequential improvement in same-store sales this quarter versus the fourth quarter. And every journey has to start somewhere, and I think that journey started in the fourth quarter of 2015.”
Add in a generally strong performance by KFC and Taco Bell and you can’t discount the long-term attractiveness of YUM stock despite the troubles Pizza Hut is currently facing. If pizza goes out of fashion, it still has chicken and tacos to tempt restaurant goers — and like investing, diversification is a good thing when used properly.
Long-term I don’t think you can go wrong owning any of these three pizza stocks.
However, for me, Domino’s is hands-down the best stock to own because of its international operations; they do a fantastic job of contributing to its overall profits without a whole lot going out. That’s just too hard to pass up in my opinion.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
