Company Reports

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.

Papa John's International sits in an interesting niche in the $93 billion global pizza quick-service restaurant market (Euromonitor), with its "better ingredients, better pizza" mantra reflecting a commitment to simpler products that are purportedly higher quality than those of its largest category peers, Domino's and Pizza Hut. The firm's positioning looks particularly favorable amid challenging inflation, with Papa John's better equipped to pass along price increases to consumers than competitors like Domino's that compete more aggressively along the lines of value. Strategically, Papa John's is focused on five pillars: people, brand, product, technology, and unit economics, with prudent menu development, effective utilization of technology, and much stronger four-wall profitability than precoronavirus leaving the firm on solid competitive footing.

Rob Lynch, president and CEO, will be departing narrow-moat Papa John's to assume the CEO position with Shake Shack (not covered). Papa John's current CFO, Ravi Thanawala, will step into the interim CEO role immediately. Thanawala joined the company as CFO in 2023 after serving as the CFO of Nike North America. His tenure at Nike included stints as Global VP and CFO of the Converse brand, and we don't believe that he's the logical long-term replacement for the CEO role, given his lack of foodservice industry experience. For now, we plan to maintain our Standard Capital Allocation Rating for the firm, which we will revisit after the board of directors announces Lynch's successor. Shares look cheap after a 5% decline in March 21 trading.

Narrow-moat Papa John's isn't resting on its laurels after growing its top line and operating income at striking 7.2% and 65% compound annual growth rates, respectively, since its 2019 turnaround. We believe that changes to its national advertising strategy should bolster already competitive economics for new stores in its largest North American market, driving an uptick in our forecast for home market development to 1.8% annual growth between 2024-28, from 1.6% previously. Taken in tandem with a more prudent approach to international development, we believe Papa John's has the right pieces in place to drive mid-single-digit (4.9%) average annual systemwide sales growth over the medium term, with a modest mix-shift toward asset-light international markets driving roughly 300 basis points of adjusted operating margin expansion over that period, to 10.4% in our 2028 midcycle forecast year. As we digest the firm's strategic roadmap and strong quarterly results, we expect to increase our $72 fair value estimate by a mid-single-digit percentage, consistent with the market's reaction in Feb. 29 intraday trading.

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.

Papa John's International is in an interesting niche in the $88 billion global pizza quick-service restaurant market (Euromonitor), with its "better ingredients, better pizza" mantra reflecting a commitment to simpler products that are purportedly higher quality than those of its largest category peers, Domino's and Pizza Hut. The firm's positioning looks particularly favorable against a challenging inflation backdrop, with Papa John's better equipped to pass along price increases to consumers than competitors like Domino's that compete more aggressively along the lines of value. Strategically, Papa John's is focused on five pillars: people, brand, product, technology, and unit economics, with prudent menu development, effective utilization of technology, and much stronger four-wall profitability than precoronavirus leaving the firm on solid competitive footing.

Narrow-moat Papa John's posted tough third-quarter earnings, with pressure in its recently acquired U.K. stores and unit growth softness sending shares spiraling (down 4%-5%). We expect to lower our $76 fair value estimate by a mid-single-digit percentage after mulling over results, leaving shares trading at about a 15% discount to our revised valuation.

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.

Papa John's International is in an interesting niche in the $88 billion global pizza quick-service restaurant market (Euromonitor), with its "better ingredients, better pizza" mantra reflecting a commitment to simpler products that are purportedly higher quality than those of its largest category peers, Domino's and Pizza Hut. The firm's positioning looks particularly favorable against a challenging inflation backdrop, with Papa John's better equipped to pass along price increases to consumers than competitors like Domino's that compete more aggressively along the lines of value. Strategically, Papa John's is focused on five pillars: people, brand, product, technology, and unit economics, with prudent menu development, effective utilization of technology, and much stronger four-wall profitability than precoronavirus leaving the firm on solid competitive footing.

Narrow-moat Papa John's International delivered unsavory fiscal 2023 second-quarter results—$515 million in revenue and $0.59 in diluted EPS trailed our $527 million and $0.71 estimates before the earnings call, respectively. Given the negative comparable store sales growth in its U.S. arm (91% of sales, down 1%), management guided to a flat to 2% full-year U.S. comp growth (from 2%-4%, previously), though this suggests sequential improvement in the back half of the year. Moreover, its long-term annual unit growth expectation (through fiscal 2025) was tempered to 5%-7% (from 6%-8%), and we intend to adjust our forecast into the guided range. All in, this should reduce our $77 fair value estimate by a low-single-digit percentage, leaving shares a touch overvalued.

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.

Papa John's International is in an interesting niche in the $88 billion global pizza quick-service restaurant market (Euromonitor), with its "better ingredients, better pizza" mantra reflecting a commitment to simpler products that are purportedly higher quality than those of its largest category peers, Domino's and Pizza Hut. The firm's positioning looks particularly favorable against a challenging inflation backdrop, with Papa John's better equipped to pass along price increases to consumers than competitors like Domino's that compete more aggressively along the lines of value. Strategically, Papa John's is focused on five pillars: people, brand, product, technology, and unit economics, with prudent menu development, effective utilization of technology, and much stronger four-wall profitability than precoronavirus leaving the firm on solid competitive footing.

Narrow-moat Papa John's International reported solid quarterly earnings, with $527 million in revenue and $0.68 in adjusted EPS effectively in line with our $529 million and $0.69 estimates. Encouragingly, the firm maintained its guidance for 2%-4% U.S. comparable store sales growth in 2023, suggesting modest outperformance relative to its largest competitor, wide-moat Domino's. Further, a recently signed 650-unit development agreement in India should bear fruit, with a more value-oriented approach that focuses on delivering local market density and commensurately better four-wall economics looks more likely to bear fruit than the firm's previous foray in that market. On balance, we believe that those two factors are responsible for a 4% uptick in share prices during intraday trading, and we expect to raise our own $72 fair value estimate by a similar margin, with similar rationale. Shares continue to trade in a range we'd consider fairly valued.

We're initiating coverage on Papa John's International with a narrow moat rating and $72 fair value estimate, leaving shares trading in a range we'd consider fairly valued. The firm is the third-largest limited service pizza player in its home U.S. market and fourth-largest globally, with 5,700 global units and a pipeline of nearly 3,000 more through franchise development agreements. With the company occupying the premium position in quick-service restaurant pizzas, it has proven it is better able to pass along inflationary pressures to consumers with lower elasticity, generating 10% annualized comparable store sales growth since 2019, against just 4% at wide-moat Domino's and 1% at Pizza Hut (a wide-moat Yum Brands business), by our estimates.

Papa John's International is in an interesting niche in the $88 billion global pizza quick-service restaurant market (Euromonitor), with its "better ingredients, better pizza" mantra reflecting a commitment to simpler products that are purportedly higher quality than those of its largest category peers, Domino's and Pizza Hut. The firm's positioning looks particularly favorable against a challenging inflation backdrop, with Papa John's better equipped to pass along price increases to consumers than competitors like Domino's that compete more aggressively along the lines of value. Strategically, Papa John's is focused on five pillars: people, brand, product, technology, and unit economics, with prudent menu development, effective utilization of technology, and much stronger four-wall profitability than precoronavirus leaving the firm on solid competitive footing.