Papa John's plans for profit growth after flat 1Q

In its March 30-ended first quarter, Papa John’s International Inc.’s net income was essentially flat, at $19.3 million, despite same-store sales gains of 9.6 percent in North America and 6.4 percent in its international system.

But leaders of the Louisville, Ky.-based Papa John’s told investors that some outlays in the first quarter tied to compensation and investment in unit growth would lay the groundwork for renewed profit growth in future quarters, when they expect commodity pressure to ease from the inflation currently affecting the market for cheese.

During the most recent period, the market price for cheese, the brand’s biggest commodity, averaged $2.21 per pound, compared with $1.66 per pound a year earlier.

The upshot of that kind of commodity inflation, painful as it might be in the short run, is that it weeds out weaker independent or regional competition and provides Papa John’s the chance to further differentiate itself on ingredient quality, founder and chief executive John Schnatter said during the brand’s first-quarter earnings call.

“As cost of goods goes up, the competition will let quality go down, and that will further disappoint customers,” Schnatter said. “When the competition disappoints, we’re going to pour it on with our quality focus, and we should come out ahead with a market-share gain.”

Most pizza brands do not have the ability to raise prices dramatically in the current high-cost environment, but Papa John’s continues to benefit from having staked out a price point slightly higher than that of Pizza Hut and Domino’s Pizza. The Double Cheeseburger Pizza limited-time offer in the first quarter ran at $12, and for most of last year Papa John’s would advertise its specialty pizzas for $11 when the other two brands mostly promoted items for $10.

“We’ve shown the ability to get a more premium price point over time than the rest of the category by staying true to [‘Better ingredients, better pizza’] and the customer experience,” Schnatter said. “If you drive the top line, sooner or later you figure the bottom line out. … Losing sales momentum could really cause problems, but we’re doing the opposite of that.”

[[The company saw same-store sales gains of 9.6 percent in North America and 6.4 percent in its international system during its first quarter, but its net income was essentially flat, at $19.3 million.]]

Chief financial officer Lance Tucker added that beyond commodity increases, a few other parts of Papa John’s P&L “cost us some pennies,” like a higher-than-expected effective tax rate, higher interest expense, and a $1.6 million increase in general and administrative expenses related primarily to long-term executive compensation from hitting key sales figures.

But paying out incentive bonuses to Papa John’s executives or giving royalty relief to franchisees who meet or exceed a certain high same-store sales threshold was “money well spent,” Schnatter said. Down the line, the company would be able to point to reinvestments in the brand made during the first quarter that enabled profit growth and market share gains, he said.

“All the business units were up on profitability, but the things that went backwards were executive incentives, franchisees’ incentives to get stores open and their incentives for [comparable sales],” Schnatter said. “That’s a good thing.”

Tech to keep driving sales

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Schnatter and his team are also confident that investments made in technology in the domestic system would continue to drive sales and that the international business would remain a source of profit growth.

Officials noted that Papa John’s drove more than 45 percent of its domestic sales via digital-ordering channels and predicted the brand would be the first major pizza chain to reach 50 percent of sales coming from online and mobile ordering. Already, nearly 60 percent of Papa John’s delivery sales in the United States come from digital channels, they said.

The chain also began its rollout of a new point-of-sale system called “Focus” in the first quarter, which is its first new systemwide POS upgrade in about 15 years.

Schnatter noted that its two larger competitors, Pizza Hut and Domino’s Pizza, have about 6,000 restaurants internationally, “so we feel like there’s a lot of runway for international growth.” He and fellow Papa John’s executives were bullish that brand could grow rapidly from its base of 204 restaurants in China.

They would not give a near-term target for when the China division, which consists of nearly 60 company-owned restaurants in Beijing and another 150 franchised locations in eastern and southern cities, would reach systemwide profitability, though they did note that the division’s profit margins were improving.

“Versus one year ago, we have a lot more scale, and scale drives everything in this business,” Tucker said. “China is a great market, regardless of who owns it.”

At the end of the first quarter, Papa John’s operated 666 company-owned restaurants and franchised another 2,615 locations in North America, and it had another 1,159 units in its 34-country international division.

Contact Mark Brandau at [email protected].
Follow him on Twitter: @Mark_from_NRN