Papa John’s Earnings: Still Some Upside After Development and International Woes Send Shares Reeling

Narrow-moat Papa John’s PZZA 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 firm’s sales results weren’t terrible—$532 million in sales edged our $529 million forecast on 3% comparable sales growth in the U.S.—but margin performance was bleak, with the firm’s 6.1% operating margin falling meaningfully shy of our 7.6% estimate as its 118 recently acquired U.K. stores caused some indigestion. More importantly, pressure from that market is set to bleed into 2024 results, suggesting a longer-than-expected route to durable margin expansion. Development posed the other major blemish on the pizza chain’s quarterly scorecard, with the firm pulling down its 270-310 net unit growth target to 245-260 new stores in 2023—a sizable revision given that we’ve already entered the fourth quarter and particularly notable given that we haven’t seen similar pressure from the firm’s publicly traded peers. Management also suggested that it will likely fall short of its 5%-7% long-term development target in 2024; we plan to lower our mid-5% forecast to roughly 4.5%, accordingly.

Otherwise, we’re intrigued by the firm’s decision to raise its targeted commissary operating margins (the segment supplies franchisees using a cost plus model) to 8% from 4% over the next four years. The timing suggests that the move is being used to offset weakness elsewhere in the business, but we suspect that the net result should be somewhat accretive to medium-term operating income. While we’ve marked our domestic unit growth estimates down by 0.25%-0.5% per year as a consequence (lower franchise margins reduce development appetite), a 10%-11% commissary margin isn’t egregious, falling in line with wide-moat Domino’s.