The Best Slice of the Pie

By Jon Quast - September 9, 2012 | Tickers: DPZ, PZZA, YUM | 0 Comments

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Although pizza started in Italy, it has become a staple of the American diet.  It's hard to imagine a city in the USA without a pizza shop.  I once lived in a town of about 300 people; too small to support a standalone pizza place.  So the only gas station in town had frozen pies they'd bake for you in 15 minutes...in the gas station.  Yep, we like our pizza.

When it comes to pizza chains, which ones make good investments?  More importantly, which one makes the best investment?  Today, I'd like to compare three pizza chains side by side: Papa John's (NASDAQ: PZZA), Domino's Pizza (NYSE: DPZ), and Yum! Brands' Pizza Hut (NYSE: YUM).  Right here at the start I'll say that I realize it might be a little unfair to compare Papa John's and Domino's to Yum! because Yum has the KFC and Taco Bell chains which help their results.  It's a valid point but it's too bad.  We simply can't look at Pizza Hut's stock, because it is tied in to Yum.  We'll just have to try to zero in on just Pizza Hut where we can.

Here's a chart of how these companies stack up in a few select metrics:

*They did have a special $3/share dividend in March

**This number represents all of Yum's portfolio, not just Pizza Hut

Papa John's

Let's start with the "little" guy.  I think these guys make the best pizza of the major chains, although that means relatively little when it comes to investing.  As we compare this stock to it's two competitors, we see that Papa John's has both the highest P/E and Forward P/E ratio of the bunch.  This could either be signaling that Papa John's is overpriced compared to it's competitors, or it could be signaling that people are expecting Papa John's to be the best growth opportunity of the three.  There is a case to be made for the latter.

When you look at Papa John's international growth so far, you'll notice something very interesting.  Of the 33 countries they operate in, 10 are considered to be middle eastern countries.  That may seem strange as we don't always associate the middle east with growth.  We normally think of Asia.  But did you know that Qatar was the fastest growing GDP in 2011 according to CIA world factbook?  Did you know that Turkey was number 3 according to the same data?  I bet you didn't.  The region has experienced tremendous growth over the last decade, and continues to grow.  Papa John's is attempting to be the pizza guy in those countries.  And if those facts don't appetize you, consider that PJ is also in China and India, the two most populous nations in the world.

They may not be the biggest competitor, but they are a real contender in the business.  They are pricey, but they are also positioned for growth.  They don't have a dividend, but Domino's doesn't have a consistent dividend either and Yum's is pretty humble.  

Yum! Brands

Like I already acknowledged, Yum is not a pure pizza play.  But you can't talk about pizza, and leave Pizza Hut out of the discussion.  Yum has the biggest market cap of the three.  They also have the lowest P/E of the group and a smaller Forward P/E than Papa John's.  This could signal a value investing opportunity, or this could mean that investors believe Yum will grow slower than competitors.  Many will point out the slowing economies of Europe and China to make a case against Yum.

Pizza Hut, like Yum in general, is focusing a significant portion of their efforts in China (hence the bears).  Pizza Hut is a major player in China with nearly 700 locations in that country.  They decided a while back that a new image was needed and made a transition from the fast food image to a casual dining image.  The result is the very aptly named Pizza Hut Casual Dining.  This new image has propelled Pizza Hut to fantastic returns in China, and has caused management to label this chain a "power brand."  This past quarter saw an increase of 28% in new units. These new units also boast a cash payback in just 3 short years.  That means the money Yum spends to open a new store will be made back in 3 years time.  That is extraordinary.

Even if this stock was just for Pizza Hut, I would still think it to be a good investment.  The investment just gets sweeter with the KFC and Taco Bell brands.  The dividend is humble, but it has a record of consistent growth, and is better than competitors.  Good buy and hold.

Domino's Pizza

Domino's, unlike Yum, is a pure pizza play.  The claim is that they are "the recognized world leader in pizza delivery."  Ok.  What do they look like as an investment?  In the chart above, they are right in the middle of most categories.  If you were a shareholder in March, I'm sure you enjoyed that big fat $3 dividend, but other than that there is no quarterly dividend.  They are in over 70 countries.  That's not as many as Yum, but it is nothing to be ashamed of.  What has got me interesting is the Forward P/E of only 15.96.  Based on the way that Domino's is positioning itself for growth, I believe this is a bargain.

There are several reasons why you should like the growth opportunities that Domino's gives you.  First, they are determined to grow around the world, both in old markets and new ones.  This month they opened their first restaurant in Nigeria in the city of Lagos.  Nigeria is becoming a powerhouse in the African economy, and many businesses want in.  So far things look good for Domino's longterm growth not only in Nigeria, but in the West Africa region.

While Domino's is an international business, you can't ignore that the bulk of the restaurants are located in the United States.  It is here that they have struggled.  Management recognized the struggles, and started to make a shift in 2008.  Since recognizing the need for change, 80% of the menu has been redone.  But what I find most interesting is the complete repositioning of the brand itself in the states.  The have swapped out their old logo for the new logo, which is just a plain red and blue domino.  They feel like this move will give them logo recognition comparable to Nike.  Also Domino's has recently unveiled the "store of the future."  This store is a play on a movie theater concept, and your pizza is the feature film.  When tries to explain exactly how this new store functions, it doesn't sound like the thing that will turn Domino's in the United States around.  But when you see the pictures of what this thing looks like, you start to imagine how it works and you can see how this could have a major draw and get US sales back on track.

Conclusion

I am bullish on all three of these companies.  I like the possibilities along the horizon for all three.  But if I had to pick the best of the pizza plays, I would say Domino's.  I really like how they're growing overseas, and I like what they are doing in the US.  Overall Domino's is making a string of good choices, that I believe will lead to better profits and shareholder value down the road.

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