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Bear of the Day: Papa Johns (PZZA)

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Papa Johns (PZZA - Free Report) wound up at the Zacks Bear of the Day several times in 2018, thanks to the fallout from an incident in July in which founder and former CEO John Schnatter was reported to have used racist language during a conference call and was subsequently pushed out of his roles at the company by the board of directors.

It was a rocky ride through the rest of the year as well as Schnatter and the board wrestled for control of the company, culminating in the board enacting a “poison pill” provision, guaranteeing Schnatter couldn’t gain a controlling interest as they searched for a buyer and/or merger partner.

Things were looking up just a few weeks ago when the company announced that hedge fund Starboard Value was making a $200 million investment, expecting to turn Papa Johns around. Starboard will own between 11-15% of the company and also name its CEO, Jeffrey Smith as Chairman of the board at Papa Johns.

Despite the infusion of cash – and Starboard also has the option to purchase a additional $50M in shares – it remains a very difficult time for Papa Johns, as evidenced by 2018 same store sales that fell 7.3% in North America and 10.5% in January of 2019.

The revenue woes are likely to continue as Papa Johns finds itself in the middle of a price war in the take out pizza business. Pizza Hut, Little Caesars and Dominos are all heavily advertising $5 and $6 menu items – loss leader pricing that suppresses gross margins.

Papa Johns’ franchisees are coming off an extremely difficult year and can ill-afford to lower retail prices, leaving the company in the unenviable position of having to compensate franchisees for the promotions needed to compete in the competitive market.

Though the Starboard investment may well save Papa Johns in the long run, there is likely more pain to come in the immediate future.

Revenues for the current quarter are expected to be down 20% from a year ago and net earnings are forecast to be 75% lower. The current Zacks Consensus estimate has fallen more than 50% in the past 30 days, from $0.32/share to just $0.16/share.

Those reductions earn Papa Johns a Zacks Rank #5 (Strong Sell).

The take out pizza business is a very competitive place to be right now and investors would be wise to steer clear altogether until the smoke clears, but its obvious the Papa Johns, still reeling from its past difficulties is in even worse shape than most.

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