A Strategic Look at This Pizza Company

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

All businesses constantly engage in a type of warfare against competition, product obsolescence, and negative perceptions. With that being said, looking at pizza restaurant chain Papa John’s International (NASDAQ: PZZA) from the perspective of strengths, weaknesses, opportunities, and threats will give you a good idea of the company’s investment merits.

Strengths

NFL partnership – Papa John’s is in a partnership with the National Football League. The popularity of American football adds eyeballs to Papa John’s promotional efforts, translating into higher sales for the company. The Super Bowl coin-toss promotion proved very popular according to Papa John’s latest earnings call.

Management ownership – Managers and employees who own a significant stake in a business will take better care to ensure its success. If they don’t, then a considerable portion of their wealth will disappear. Founder, Chairman, and Chief Executive Officer John Schnatter owns 27% of the company he founded right after finishing college. He understands sweat equity.

Company stores – Same store sales for the North American company-owned stores increased 4% in the most recent quarter, quadrupling the same store sales increases of its domestic franchise units. The reason lies in the fact that company-owned stores operate in a more established market with advertising catered to the local market.

Gold standard – Papa John’s “Gold Standard” ensures uniformity of product across the board internationally. A Papa John’s pizza in China and the U.K. will be similar to the one you find in the U.S. under this standard.

Quality product – Papa John’s higher quality product enables the company to charge a slightly higher price for its pizza. Papa John’s pizza certainly stands out.

Online experience – Papa John’s provides an excellent online interface where you can go online and order pizza. On the ordering portal, you interactively build your pizza by simply clicking on a picture of a topping and immediately seeing what your pizza will look like. This engages the consumer adding to their hunger as they order. In addition, you can build reward points towards a free pizza.

Weaknesses

Franchisee owned stores – In Papa John’s most recent quarter, its franchisee owned same store sales only increased 0.8%. This represents a quarter of the same store sales of the domestic corporate stores mentioned above. Even more worrisome, the CEO said that corporate performance exceeded the franchisee performance on every single internal metric. The disparity in performances between the two types of stores bears watching.

Number of stores – Papa John’s operates 4,200 stores, a small amount compared to the 10,330 stores operated by Domino's Pizza (NYSE: DPZ) and the 12,900 Pizza Huts owned by Yum! Brands (NYSE: YUM). This gives Yum! Brands and Domino's greater pricing power than Papa John’s.

Opportunities

International expansion – Papa John’s international operations represent the company’s best opportunity. Its international same store sales increased 8% versus 2% for its North American unit. International revenue increased 18% in its most recent quarter. Its international revenue only makes up 6% of its overall revenue, meaning there’s room for growth.

Franchisee retraining – Papa John’s corporate team is going out to talk to franchisees about best practices to improve performance.

Threats

Competition – As mentioned above, Yum! Brands’ Pizza Huts exceed the number of Papa John’s by about three times, giving them greater ubiquity in terms of pricing power and consumer awareness.

In the United States alone, the number of Pizza Huts is around 6,232, vastly exceeding Papa John’s global count.

Yum! Brands already possesses a major presence in international markets. Yum! Brands operates 1,063 Pizza Huts in China as of the most recent quarter. It also operates 310 Pizza Huts in the India Segment as well. In other international markets, it operates 5,300 Pizza Huts.

The Pizza Hut chain in China survived the Avian Flu scare relatively unscathed. So, Papa John’s competition from Yum! Brands remains as intense as ever.

Domino's store count exceeds Papa John’s by a more than a 2 to 1 margin. Over half of Domino's stores operate on the international scene. Its international same stores sales grew 7% in Domino's most recent quarter.

In addition, Domino's lacks the same weakness as Papa John’s concerning domestic franchise stores. Domino's same store sales for its domestic franchise stores increased 6% versus 5% for its company-owned stores.

However, Domino's balance sheet comes loaded with debt, even to the point where liabilities exceed assets and it runs a stockholder’s deficit. Domino's operating income exceeds interest expense by only four times. The standard rule of thumb for any company should be five times interest expense. Papa John’s operating income exceeds interest expense by 46 times. Domino's ubiquitous advantage gets undermined by its sub-par balance sheet.

Papa John’s also faces challenges from major privately held players such as Little Caesar’s, which operates thousands of restaurants as well and was one of the first pioneers of the take out concept.

Moreover, Domino's and Pizza Hut also possess an online ordering platform that can effectively compete with Papa John’s. While operating an online platform gives the three companies a slight edge over the mom and pop player, it levels the playing field among the top three publicly traded pizza chains.

PR Mishap – Possible lawsuits resulting from the recent racial slurs of a former Papa John’s employee could prove detrimental to the company’s fortunes and valuable brand name.

Conclusion

In summary, Papa John’s strengths and opportunities outweigh its weaknesses and threats. Its powerful partnership with the NFL, a manager-owner who believes in and stands by the brand, combined with a quality product, provide this company the strength to deliver decent returns to its shareholders. Papa John’s definitely deserves a look.

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William Bias has no position in any stocks mentioned. The Motley Fool owns shares of Papa John's International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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