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Bull of the Day: Papa Johns International (PZZA)

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Savvy investors know that the landscape can change rapidly. A company with the strongest financials can run into trouble based on circumstances that were totally out of the control of management. The flip side is that companies that appear to be in trouble can turn things around, sometimes dramatically.

Two years ago, it looked like Papa Johns International (PZZA - Free Report) was on the ropes. The company’s founder and CEO John Schnatter became embroiled in some embarrassing incidents during a period in which the national pizza chains were locked in a price war that saw the retail price of a take out pizza at (or occasionally below) cost.

Papa Johns franchisees were frustrated with the reputational damage to the brand at exactly the time they could least afford it. Schnatter’s comments about the NFL’s handling of player protests cost Papa Johns a lucrative sponsorship deal as well as his CEO position. The alleged use of a racial slur during a company training session caused the board to strip him of his position as Chairman. Schnatter has filed a lawsuit challenging the board's action.

Over the course of the next year and a half, Schnatter - who founded Papa Johns by himself in 1984 in the back room of a Jeffersonville, KY bar - reduced his ownership stake in the company from 30% to less than 4% of outstanding shares.

Schnatter was temporarily replaced by franchisee and long-time company insider Steve Ritchie and subsequently by former Arby’s president Rob Lynch. Management immediately went to work shoring things up with the backbone of the business – the owners of the more than 2,400 franchise locations. The company extended discounts on supply contracts, loan forbearance and other generous terms to ensure that the franchisees were happy in their roles as the everyday face of the business.

They then turned to the task of replacing Schnatter in his role as the company’s main spokesperson and they pretty much hit the jackpot - landing ex-NBA star Shaquille O’Neil who is not only featured prominently in advertising, but also owns a multi-unit franchise operation and sits on the Board of Directors.

With his unassuming, everyman persona and famously large appetite, “Shaq” is the perfect endorser for the company's products. His signature pizza – the “Shaq-a-Roni” – features copious toppings and extra-large slices (of course), plus a donation to community-building and social justice charities.

The financial results speak for themselves. 2020 revenues are on pace to exceed 2019 by 11%. The net earnings figures are even better, with analysts expecting full year earnings to show a 20% increase and 2021 to be up more than 65% from there.

The most recent quarterly earnings report supports those lofty expectations. Sales of $461 million were a 15% year-over-year increase and earnings of $0.48/share beat the Zacks Consensus Estimate by 20%.

Though the revenue figure was a slight miss of analyst expectations, the split results actually tell an important story. Missing on the top line but still beating on the bottom is an indication of both strong margins and improving operational efficiency.

Papa Johns is also lucky enough to operate in a format that works well for the need of consumers during the Covid-19 related lockdowns. Restaurants that previously relied on on-site dining are suffering, but the take-out and delivery business is booming.

The fast-food and quick-serve restaurant industries tend to be plagued by price competition and loss-leader “special value” deals that rely on the premise that customers will also purchase other items like sides and sodas to add back profit to the check.

Establishing brand loyalty that keeps customers ordering full-priced menu items can often be the difference between surviving and thriving – and that’s exactly what Papa Johns is doing.

With rapidly rising earnings estimates and a Zacks Rank #1 (Strong Buy), it’s safe to say that this once-troubled operation has completely turned things around.  

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