Analysis: $9.00 target
Pizza Pizza Royalty Income Fund
(PZA.UN-T) C$7.83
Initiating Coverage With a BUY, $9.00 Target
Event
We are initiating coverage on Pizza Pizza Royalty Income Fund
(PZA.UN-T) with a target price of $9.00 and a BUY rating.
Details
There is no doubt that the tough economic environment weighed heavily on
discretionary spending and the resulting shift away from ‘eating out’
contributed to some very lean times for most in the Canadian restaurant
industry. Pizza Pizza was not immune, highlighted by consolidated SSS
which at their worst bottomed at nearly -8%. However, now that the economy
is arguably back on the road to recovery, not to mention growing sales
momentum in the dominant Pizza Pizza brand and what we think is the
successful competitive repositioning of Pizza 73 in Alberta, we argue that
the worst is now behind the company.
That said, with Pizza Pizza units trading at only 10.5x tax-affected forward
P/E (i.e., for the 12 months ending September 2011) – versus an average of
15.5x for the peer group – it appears that valuation is still reflecting, at least to
some degree, the roughly 18-month period of negative sales comps. However,
we expect Pizza Pizza’s growing sales momentum, decent forecasted organic
bottom line growth, untapped network growth opportunities, and improving
restaurant trends to eventually push Pizza Pizza’s valuation back in line with
industry peers, if not a bit higher.
Taken together, we are initiating coverage on Pizza Pizza with a BUY
recommendation and a $9.00 target price. Combined with 9% dividend yield,
our $9.00 target represents a 24% return.
1. What drives SSS, have they bottomed, and how can Pizza Pizza drive more growth?
? We believe that SSS, which, in our analysis, are heavily dependent on economic factors, have
bottomed and Pizza Pizza will be lapping easier comps through H1/11. Specifically, the improving
economic backdrop and employment trends in particular, suggest that SSS should continue to recover
through to the end of 2011.
? From a company-specific standpoint, we believe Pizza Pizza has room to boost sales by a modest clip
with the introduction of pasta to the menu line-up, which in our opinion, was the only remaining hole left
on the menu. In addition, new gourmet pizzas, improvements to its sauces and dough, and 15% more
cheese on whole and individual slices should all be positive for SSS.
? It is taking longer for western Canada to rebound economically, and this is placing ongoing pressure on
Pizza 73 sales. But we expect it to catch up by next year. On top of lower food costs at the Calgary and
Edmonton commissaries, the new pricing initiative (i.e., customers now have the option to purchase a
single pizza) put in place to drive sales have us feeling confident that Pizza 73’s fortunes will continue
to build on the positive turnaround in Q3/10.
2. Is there room for new restaurant development?
? Internally, we estimate there may be room for another ~160 net new Pizza Pizza restaurants (~6-8
years of growth) in Canada. The opportunity is arguably greatest in Quebec but we also see some
potential to expand in British Columbia and the Prairie Provinces longer term.
? Expansion beyond our estimated 160 new Pizza Pizza locations would require taking share from
the competition or acquisitions, in our opinion. We believe that there are probably four or five
interesting brands left in Canada that would provide Pizza Pizza with either a substantial boost to its
already dominant position in Ontario and Alberta or instant scale in areas where its presence remains
minimal.
3. What does this mean to Pizza Pizza’s earnings power and valuation?
? Even as the resuscitation of the Pizza 73 network continues, we note that the other 85% of the business,
i.e., Pizza Pizza, is showing positive signs and growing momentum. This is expected to produce
improved consolidated results over the forecast horizon. At the same time, and supported by a
correlation analysis, we find that the unit price appears largely driven by SSS trends. In other words,
higher sales growth should in turn push valuation higher.