- WHITE PAPERS
Ryan Detrick is an atypical stock watcher. He doesn't look for stocks about which other analysts wax poetic, he seeks out the ones that, in the words of the late Rodney Dangerfield, "don't get no respect."
That includes stocks whose prices are increasing without the praise or attention of market watchers, like those of publicly traded pizza companies.
California Pizza Kitchen's stock caught the Cincinnati-based Schaeffer's Investment Research analyst's eye in July, when the chain upped its earnings projection for 2005. When the 182-unit company posted an 8.6 percent comparable-store sales gain for the second quarter, the price of the once-questionable stock began an ascent to a year-to-date high of $33.18.
"We are contrarians who play stocks that are able to rise on analysts' pessimism and skepticism," said Detrick, simplifying Schaeffer's strategy. "When I found out each of them were making 52-week highs or near it, that made me think there's probably more money on the sidelines that could very well move in and buy. That drives prices up."
The question of why so many analysts are cool on otherwise hot pizza stocks doesn't yield a single, simple answer. Market watchers do look for solid, steady businesses like those companies mentioned, but often they're more eager to find what's hot — stocks that produce impressive returns quickly.
But in the highly competitive quick-service food industry, such sexy returns on investments aren't all that common, and certainly not in the post-recessionary new millennium.
In the 1990s, Papa John's rode the price rocket to above $50, before sliding back to $19 by 2001. CEC Entertainment, parent of Chuck E. Cheese's Pizza, split its stock nearly three years ago when its price soared above $60. But after flirting with the $44 mark in July, the price has slipped back to $35, despite delivering pizza category earnings per share second only to Papa John's.
Domino's was largely ignored when it went public a year ago at $14 a share. It climbed significantly, however, to more than $25 in August, but it hasn't garnered much analyst attention.
That kind of a price increase without much coverage is a green flag to Detrick.
"That means it's been able to do this without the participation of institutions or big brokerage houses," he said. "So, should they jump on board, that will bring an influx of potential buying pressure and force prices higher."
Lynn Liddell, executive vice president of investor relations and communications at Domino's, said being ignored thus far sends two messages: investors are looking for quicker returns than an established company like Domino's typically delivers; and/or they don't understand the company's potential.
"Our story has always been that we're a long-term play," Liddell said. "Some quarters will be fabulous, some not so fabulous. But if you look at our history, you see a successful, steady business model
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While the returns produced by an industry giant are pretty predictable, Liddell said what's more important is the fact that pizza consumption is even more predictable. "People eat pizza, plain and simple. It's a luxury that's affordable for most anyone. Also, Domino's has been around for 45 years, and the company hasn't had a negative annual sales comp in 11 years. This is not a company that's going away."
Beating the market
Analysts agree that the rise in pizza stock prices is good news for the category overall. The notion that a rising tide floats all ships is clearly at work as pizza demand, even among independents and regional chains, is strong.
But perhaps most notable about the performance of some pizza company stocks is their standing against other stocks. Not only are they outperforming broad restaurant industry peers, they are, in some cases generating greater returns than some Standard & Poor's 500 companies. For example:
* Papa John's projected EPS for 2005 is $2.23, compared to the foodservice industry's $1.47 average and the S&P's $1.84 average.
* Chuck E. Cheese's is projected to earn $2.19, compared to the foodservice industry's $1.47 average and the S&P's $1.84 average.
But despite their soaring stock prices, California Pizza Kitchen and Domino's are expected to finish below both the industry and the S&P 500, turning in EPS of $1.17 and $1.38 respectively. (Domino's, which is the only public pizza player scheduled to pay a shareholder dividend in 2005, plans to dole out some 40 cents per share.)
By comparison, industry giants McDonald's and Wendy's are posting modest comps and losses, respectively, pointing to softness in the burger segment.
"In general, it does look like the pizza category is holding up perhaps a little bit better than other sectors of the restaurant industry," said Mark Kalinowski, an analyst with Buckingham Research Group in New York. "We think that, in small part, that's because people might be driving a little bit less, which means they're at home more, which is good for delivery companies."
Kalinowski also suspects the growing number of American males is helping pizza sales; they like deals like Domino's 5-5-5. Plus, the weakening low-carb craze has customers focusing on pizza instead of misplaced feelings of guilt.
He also is impressed that pizza companies realize they don't have to copy each other to succeed. Where Domino's has promoted value, Papa John's has focused on customer service and product innovation to gain ground. California Pizza Kitchen, on the other hand, is trumpeting its unique gourmet pizzas and broad-ranging food and bar menus to win in its niche.
"It's interesting to see that you can have all these companies succeeding in the long run with fairly different strategies," he said. "And you can't overlook the fact that they always are competing against strong mom-and-pop operators and regional chains."
Sticking to those proven strategies rather than
We feel if we take care of operations and running restaurants, sales will come, the system will grow and the stock price will take care of itself.
— Chris Sternberg,
"To some extent, the stock price is outside the company's control anyway," he said. "What's worse, expectations sometimes can get raised on Wall Street to levels that are unsustainable, even if your business is running very well."
Papa John's suffered that curse in the 1990s, when it opened an average of 350 stores per year. Communications vice president Chris Sternberg said it was simpler for the company to generate earnings increases and cash flow when the chain was cutting into new territory. But since the category has firmed up, boosting share value is tough.
"Back then you had dollars chasing companies and betting on future growth prospects," said Sternberg. "But clearly, valuations got ahead of themselves, and in the late '90s, you saw a contraction of the category when some companies fell by the wayside. I think those companies that focused on the fundamentals and stayed true to their business models have emerged stronger. And the valuations are a lot more reasonable than they were in the '90s."
Despite stock price improvements, not every investor agrees these pizza companies will continue enjoying increases. That sentiment is evidenced in the amount of short selling of some pizza stocks. When a stock is short sold, the investor is placing a bearish bet that the price will drop. According to Detrick, when short sales as a percentage of all outstanding shares meets or exceeds 10 percent, that's significant.
More than 17 percent of Papa John's shares are shorted, while 9 percent of California Pizza Kitchen's shares are. But in contrast, only 4 percent of Chuck E. Cheese's and just 1 percent of Domino's are short sold.
What's an investor to make of it all? Detrick said one needs to look deeper at the long-term trends. In 2004, for example, 30 percent of Papa John's shares were shorted, indicating strongly negative attitudes about its price. But this year's nearly 13 percent reduction in short sales "shows a definite unwinding of negative pessimism" about the stock, and its fundamentals prove the business is on solid footing, he said.
In the end, Detrick said, investors have to decide whether they want the stock for the long haul or for the short pop, and that such indecision can influence prices unfairly.
Despite that, both Domino's Liddell and Papa John's Sternberg say their companies' job is to focus on operations, not stock prices or analyst concerns.
Sternberg said Papa John's made a deliberate decision to avoid Wall Street's attention from 2001 to 2004, when its business needed tweaking. The company closed underperforming stores, trimmed corporate staff, polished its marketing and took unprecedented steps to develop a new product pipeline.
The result was the rollout of several successful pizzas, multiple first-place finishes in the quick-service category of the American Customer Satisfaction Index survey and consequent comparable-store sales gains.
"We realized that, maybe in the past, we'd not done a good job keeping our loyal customers interested in us with variety, but we've since done that with two new pizzas and a real focus on service," Sternberg said. "We feel if we take care of operations and running restaurants, sales will come, the system will grow and the stock price will take care of itself."