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Don't nobody know nothin' ''bout this business?

Tough times in the pizza business have Editor Steve Coomes scratching his head, too, but he's making a guess as to what will happen next.

May 28, 2003

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An article in the May 28 Wall Street Journal quoted Bill Nygren, a 44-year-old portfolio manager of the Oakmark Fund, touting shares of Yum! Brands. Nygren correctly pointed out that the stock "has been doubling earnings at a double-digit rate" since its spin-off from PepsiCo in 1998, and he expects such returns to continue unabated.

Further in the article, however, Nygren said Yum was doing well because it hadn't suffered from negative market forces, such as the recession, plaguing other businesses. Purchases made at Yum restaurants -- Pizza Hut, KFC, Taco Bell, Long John Silver's and A&W All American Food -- are small, discretionary buys, and aren't affected by a down economy.

Hmm. Try telling that to Pizza Hut, one Yum company that could use a few million discretionary purchases about now.

Steve Coomes, Editor

And then try it on Papa John's and Domino's Pizza and a lot of other quick-service companies battling negative comp-sales trends. Be it market forces or otherwise, the decrease of those small discretionary buys is costing the U.S. pizza biz millions.

Clueless

I once worked in a restaurant with a lady named Shirley, who disdained debate of any issue more high-browed than sports rivalries and who shot J.R. Ewing (Her answer to the latter, by the way, was half right: "He had it comin' to him, even if Sue Ellen didn't do it.") If staff talk centered on an issue she felt powerless to alter, such as U.S. politics, she inevitably tried to stop the discussion with, "Y'all don't know nothin' 'bout nothin' no how. If you did, you wouldn't be here cookin'!"

Her success rate in derailing such rare, thought-provoking conversations was high, and probably because she had a point: Not even the supposed experts, like Nygren -- much less her clock-punching peers like me -- have a clue sometimes.

But that doesn't stop our desire to unknot the tangled webs of our world, which is what many in the pizza industry are doing right now. Judging by the conversations I had in the aisles at the recent National Restaurant Association show in Chicago, over the phone and via e-mail, I know that my current conundrum -- What's happening to the U.S. pizza industry? -- is yours, too.

People such as Mark Laramie, president of Vancouver, Wash.-based Papa Murphy's Take 'N' Bake Pizza, and Bob Mazziotti, Detroit-based Little Caesars' vice president for U.S. development, say it's just a down cycle that will rise again. Having watched and worked in the pizza industry since the Nixon Administration, both men certainly have history to back their beliefs.

Outsiders, like Alan Levitt, are curious about the industry, too. The Crystal Lake, Ill., dairy industry analyst called me several days ago to discuss what he believes is happening from the cheese-manufacturers' perspective. But when I hung up 56 minutes later, I wasn't sure I'd helped him at all. As if Shirley herself had been there to remind me, I had the feeling that I didn't know too much about anything.

The conversation did, however, firm up a few of my beliefs:

1. The pizza industry is amid a major correction, as demonstrated in some leading indicators:

* ongoing sales declines and flat net domestic store growth at the top three chains;
* flat to negative sales in restaurant equipment;
* reduced production of and use of domestic mozzarella cheese

2. Other quick-service and quick-casual restaurant industry segments with similar price points are producing positive numbers. Sales at sandwich and Mexican concepts continue to surge upward.

3. Pizza is not recession proof, as many thought back in 2001. It was thought that the down economy would play in to operators' hands because of pizza's affordability, but that hasn't been the case.

And were the recession so bad that people who couldn't afford pizza would be forced to go to the grocery to buy and -- heaven forbid -- cook their own food, there's no evidence to prove it. Grocery sales continue to slip as people dine out more often.

4. The grow-as-fast-as-you-can strategy that dominated pizza in the 1990s is dead. The U.S. pizza industry is bloated to the point of overcapacity. While no other restaurant industry segment sees so many shops open every year, almost the exact same number closes. Growth in market share for one company comes at another's expense because there is no significant number of new customers in the U.S. market. Do the math and you'll see it's a zero sum game.

So where's the money gone?

If any segment of the industry has weathered the recession well, it's casual dining -- those restaurants in the middle ground. Take the dollars once spent on fine dining, and cut pizza purchases from six times a month to four, and you've got millions being diverted elsewhere. And as we already established, that money isn't going to Meijer.

Unlike the quick-service experience, casual dining customers are waited on, which is a little more special than the drive-through experience. And unlike fine-dining, a casual restaurant meal is affordable and paced quickly enough for the family on the go.

If the old saying is true, that customers speak with their wallets, then the din must be deafening in casual restaurants.

Have seat, please.

While I wish I had the dollars to conduct a scientific survey, I don't. So I'm going to blend the hard facts I've mentioned with a little hearsay in predicting this: Dine-in pizzerias, like their casual dining peers, will emerge from this recession stronger than ever. I'll highlight two companies to make my point: Los Angeles-based California Pizza Kitchen, and Goodfella's Brick Oven Pizza & Pasta, based in Staten Island, N.Y.

Both concepts are growing (CPK has 150 stores and plans to add 18 in 2003, Goodfella's has 10 and wants a total of 17 this year). The menus at both center on pizza, but are well diversified (e.g., CPK has an impressive array of salads, and Goodfella's sells wood-fired steaks cooked right on the hearth of the pizza oven), and both serve alcohol. Both offer high-quality food and service in an upbeat, family atmosphere, and both utilize multiple unit designs, ranging from 200-seaters to café size models, in their expansion.

Slow, solid growth and a focus on quality versus quantity is their plan for expansion, which, unfortunately for CPK, may not wow investors. But in the case of both companies, it will produce strong returns because good restaurants draw customers who want choice and a good meal out.

At least that's what I think, which, if you asked her, Shirley would say doesn't amount to nothin' no how.