Food for Thought, and It's Pizza!

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

Here's an interesting fact: Illitch Holdings, in addition to owning both the Detroit Redwings and the Detroit Tigers, also owns Little Caesars, the nation's fourth largest pizza chain. But investors can't grab a piece of that pie, as Illitch is a private company.

But who cares about owning the fourth best anything anyways? When investing in any industry, unless you spot an insanely cheap price, you should limit yourself to la creme de la creme, the best of the best.

With that in mind, let's take a look at the pizza chains that manage to outsell Little Caesars. And good news, the top three chains are letting investors get in on the action.

First up, the smallest 

With 4,163 locations, (includes company-owned and franchises) Papa John's International (NASDAQ: PZZA) is ranked third among American pizza chains in terms of both sales and market cap.

First, a couple of positives. The company has lowered the amount of shares it has outstanding by 19% since the end of 2009. During that time frame it also went from having a working capital deficit to a $23.7 million dollar surplus.

Sadly, a $23.7 million dollar working capital surplus isn't all that impressive for a company as large as Papa Johns.

What's more cursory, examination of the company's financial statements reveals stagnation. The kind of stagnation you don't want to allocate your capital anywhere near.

Net income for the company has grown at a 4-year compound annual growth rate, or CAGR, of 1.8%. Shareholder's equity has grown at an absolutely anemic CAGR of 6.5%... of 1% (as in 0.065%). 

Recent results have been a little better though. EPS are up 12.6% year-over-year and revenues are up 10.2% year-over-year.

Additionally, Papa John's has the lowest margins of all three of the companies I am going to discuss. When it comes to Papa John's, I would just say no. To the stock at least. 

One-third of the largest fast food chain

Largest in terms of total restaurants that is. And the one-third I am referring to is Pizza Hut, the second largest pizza chain in the nation.

Combined locations of Yum! Brands, (NYSE: YUM) owner of the fast food triad that is KFC, Taco Bell, and Pizza Hut, total 38,535. That's the largest of any publicly traded fast food company in the world (Mickey D's has 34,480) and second only to Subway.

I found it difficult to find figures on how just Pizza Hut performed. But that doesn't really matter since if you purchase the stock you aren't just buying Pizza Hut, you're getting the whole package.

Looking at the stock chart it appears that owning Yum has been quite the roller coaster lately. As I write this, the company is valued at $32.2 billion, does that valuation make for an attractive investment?

Yum does have the highest net profit margins of any of these three companies. And its portfolio of brands has incredible intrinsic value, the kind that can't be measured by any financial statement.

Then again, the company is running a working capital deficit of $191 million. But that is probably negligible considering how the company has grown shareholder's equity over the past four years. During that time period, equity more than doubled and now stands at $2.29 billion. 

Sales have grown at a 4-year CAGR of 5.9%, and in 2012 were $13.6 billion. Net income has grown at an even more rapid 4-year CAGR of 10.5%. 2012 net income for Yum was $1.6 billion. 

Additionally the company currently pays a dividend of 1.9%. Not the highest in the world, but a whole lot better than the 0% over at Papa Johns. 

One thing I don't quite understand about Yum is the way the company is conducting share repurchases. Beginning in 2011, the company began buying back its own shares which may have made sense at the time.

What I don't get is why the company has continued its buybacks in 2012 and the first quarter of this year. Management might be attempting to give a jolt to a stock that's gone practically nowhere in the past year. 

But in my eyes that's a terrible way to squander the shareholder's money. Warren Buffett says that a company should only conduct buybacks when management believes shares are undervalued.

Unless management knows something I don't, which they very well might, this company is not undervalued, at least not significantly. My examination of the company is telling me that this is a fairly valued company at best, certainly not a bargain.

Explosive growth 

Patrick Doyle deserves some sort of award. I mean the turnaround that guy has engineered at Domino's Pizza (NYSE: DPZ) is nothing short of incredible. 

In 2008, domestic stores same store sales were down 2.2%, in 2009 they were down .9%. Enter new CEO J. Patrick Doyle. Doyle took the reigns of the company in March of 2010. How has he done so far?

In 2010 the company recorded domestic same store sales growth of 9.7%, in 2011 4.1%, and in 2012 1.3%. Although it wasn't Doyle's doing, international same store sales have increased for 19 straight years!

Earnings per share, diluted and adjusted, were $0.47 in the first quarter of 2012. In the first quarter of 2009 the figure was $0.20. That equals out to a 4-year CAGR of 23.8%.

The company also recently started paying a dividend. Its yield stands at 1.3%. That's a little lower than Yum's yield of 1.9%, but Domino's very low payout ratio of 9% is 30 percentage points lower than that of Yum. 

Despite this Patrick Doyle induced growth spurt, the company still has its problems. Namely it is incredibly levered, with $1.53 billion in long term debt and shareholder's equity is a negative $1.32 billion.

While real Italians probably think Domino's is garbage (to be fair it kind of is compared with an authentic Italian pizza) personally I think the pizza is pretty good. A little greasy, but definitely delicious.

And the value is absolutely incredible, eight bucks for a large three topping pizza? I don't care if I do have to go and pick it up, that's an awesome deal if I ever saw one.

I live in a college town and 9.5 delivery drivers out of 10 that I witness delivering pizzas work for Domino's. College students aren't made of money, so most of the time they opt for Domino's. The vast majority of Americans aren't made of money either, the vast majority of Americans also love pizza.    

Foolish final thoughts

Investing in pizza probably isn't nearly as fun as eating it. Unless you hit what Peter Lynch likes to call a multi-bagger. But in the case of these three pizza companies, I highly doubt purchasing any of them will result in a multi-bagger anytime soon. 

Papa John's has been picking it up lately, but its growth over the past four years has been less than impressive. While the company has been buying back shares, shareholder's equity and net income have both gone practically nowhere over the last few years.

Yum! Brands is a company with a trio of some of the best known names in fast food. You can count on them for steady, yet unspectacular, growth. This is a company that Peter Lynch would probably classify as a stalwart.

Domino's has engineered an incredibly impressive turnaround. The company is growing incredibly fast thanks to its improved pizza and very reasonable prices. The dividend also looks very attractive, especially with such a low payout ratio. 

If I were to invest in one of these companies, it would have to be Domino's. But investors in the company need to make sure it maintains its growth. If not, investing in this company with negative equity of over $1 billion will prove to be a huge mistake.

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Fool blogger Ryan Palmer has no position in any of the 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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