Qualiport

Could this company be the next Qualiport member?

The old adage "buy what you know" has served many investors well over the years. Whilst there are many temptations to buy fast growing companies in the high technology field, if you can't touch, feel and use the product they are selling, it is that much harder to get an understanding of the company. Peter Lynch relays some of the secrets to his success in his excellent books. One of them includes walking down your local High Street and looking to see which shops are busy and which products are selling. It's not quite as easy as buying shares in the latest retail fad, or this year's number one selling Christmas toy, as you still have to do your research about the company. But it does give you a feel about the company, and being able to see and touch it allows you to assess its prospects at relative close quarters. Lynch discovered Body Shop in this fashion, although if he's still a shareholder, he probably wouldn't be too impressed with their progress over the last few years. Enough said on that one.

PizzaExpress

This is a company I've long admired. More importantly, I also like their restaurants and their pizzas. Dave and I had our early Fool meetings in the Bayswater branch, one of their oldest. I've always regretted never being a shareholder and have enviously watched as their share has gone from 82p in mid 1993 to the current price of around 660p. That's a compounding annual growth rate (CAGR) of an amazing 51.8%. This sort of growth will not be repeated in the future, but it gives you an idea of the success the company has had over the last 5 years.

The first PizzaExpress was established in 1965 in Wardour Street, Soho, London. It is no fly-by-night operation, and that original location with its relatively unchanged formula is still going strong today. As at September 1997, the founder, Peter Boizot, sill held over 3% of the share capital, although these days he is no longer a company director.

PizzaExpress listed on the London Stock Exchange in 1993, having reversed into the Star Computer Company. That computing business was soon sold, and since then they have gone on an unprecedented expansion programme, opening up restaurants in many parts of the country. The average number of restaurants in 1994 was 31. Today there are 191 across the world, although the vast majority are in the UK.

Recently, PizzaExpress has started branching out into other restaurant concepts. The first effort is called Pasta di Milano, which follows the successful pizza formula of operating with a simple menu and serves freshly prepared pasta dishes. In June this year, PizzaExpress acquired Café Pasta, a London-based chain of just 6 restaurants. The company sees significant scope for rolling the formula out across the country and sees the pasta concept as being complimentary rather than competitive to the PizzaExpress restaurants.

For those Fools who haven't been into a PizzaExpress restaurant, the concept is remarkably simple, yet effective and extremely profitable. The company is very conscious of the location and the cost of its outlets. You will see many restaurants slightly off the High Street, in converted banks or old pubs. Because the company does virtually zero marketing, and relies solely on word of mouth and repeat business to drive customers to their restaurants, they don't need to be in prominent locations.

Compare the advertising and the locations of a national chain such as Pizza Hut to the low profile backstreet PizzaExpress. No expensive washed up footballers are needed to promote the PizzaExpress name. The cheapest form of advertising and marketing is no advertising and marketing. As we see from our own business here at the Motley Fool, word of mouth is a powerful marketing tool.

PizzaExpress play on the "experience" each customer has when they dine in one of their restaurants. The typical visitor will have relatively high disposable income. Spending per head per visit is over £10. It is not a family restaurant, and can't be compared to chains such as Pizza Hut or Deep Pan Pizza. Families are altogether more cost conscious and wouldn't necessarily be attracted to a PizzaExpress. Whilst the company would be happy to have any customers walk through their doors, they are determined not to compete on price. This is a key to their success. If customers enjoy the PizzaExpress "experience," there is a very good chance they will be repeat customers. They will also tell their mates about their "experience," and so the word of mouth marketing swings into action.

The menu is deliberately very basic and largely unchanged over the years. This serves two important purposes. Firstly, customers know that whichever PizzaExpress restaurant they enter, they will get exactly the same menu choices. We are creatures of habit, and if we enjoy something once, the chances are that we will go back and have that meal over and over again. The other big advantage about having a limited menu is company profitability, as we shall see below.

Show Me Da Numbers

Company share prices rarely rise in a vacuum. Over a long period of time, consistent earnings growth will always drive the share price higher, just as the opposite is also true for struggling companies. The 5-year 51% compounding rise in the PizzaExpress share price is as a result of explosive earnings growth fuelled by the aggressive restaurant opening programme. Have a look at these earnings per share (EPS) growth numbers:

1994 +26%
1995 +34%
1996 +50%
1997 +57%
1998 +38%

These are tremendous growth numbers, the envy of any listed company. To me, the most impressive part about PizzaExpress is their absurdly high operating margin. As they've rolled out this successful formula all over the country, it has allowed them to spread the relatively low head office costs over an increasingly higher sales base. But the big thing, and we alluded to this above, is their hugely increased buying power. No longer are they some tin pot company with a few restaurants -- they are a national chain, and because of their size, they can negotiate favourable deals with food and drink suppliers and distributors.

From an operating margin of 8.7% in 1993, PizzaExpress now sports a operating margin of 22.7%. For every £100 in sales, the company makes £22.70 in profit, before taking interest charges and tax into account. That margin is in the very top echelon of quoted companies. It is not hard to work out why they can achieve such a high level of profitability. As well as purchasing power, they spend nothing on advertising, deliberately locate themselves slightly off the beaten track in lower rent premises, and have a simple standard menu. They don't compete on price, so don't get caught in a price war, and their standard customer has a high amount of disposable income. It all adds up to a very profitable organisation.

The Future Strategy

As of now, there are 179 UK company owned PizzaExpress restaurants. Only three more franchised operations exist, most of them having been bought out by the company in 1997. By June 1999, the UK will have in excess of 200 PizzaExpress restaurants. The company says that they see room, in the UK alone, for over 350 such restaurants. In the future, they will be targeting specialist locations such as airports, cinema complexes and retail/leisure outlets.

The pasta division currently has 12 restaurants, and the company plans to open at least another 10 in the 1999 financial year.

PizzaExpress is now cautiously moving abroad, and 8 franchised restaurants are already operating in places as diverse as Delhi, Cairo, Paris and Istanbul. Outlets under construction are in Moscow, Paphos and Karachi.

The PizzaExpress Snapshot

Recent share price: 660p
Market capitalisation: £437 million
1998 Sales: £99.6 m
Price to sales ratio (PSR): 4.4

1998 Earnings Per Share (EPS): 25.8p
1999 EPS estimate: 32.6p

1998 Price Earnings Ratio (P/E): 25.6
1999 Estimated P/E: 20.2

Next Week

On Wednesday, we will delve a little deeper into PizzaExpress the company. Before looking in depth at the numbers and the valuation, we want to establish that they are a quality, well managed company. Click here to see the Qualiport criteria for our ideal company.

I'd really appreciate your views on the company. I know a couple of fellow Fools are not big fans of the PizzaExpress restaurants. What's your experience? Are you a repeat customer? All thoughts and comments, as usual, to the Qualiport message board.

Have a great weekend, Fools.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers       Date    23/09/98


                  Day     Month     Year    History
Qualiport        3.76%   (7.49%)   20.76%    23.48%
FTSE 100         2.18%   (0.66%)    1.54%     3.87%
FTSE All Shares  1.67%   (1.51%)   (0.29%)    1.81%


Qualiport Stocks

Last Rec'd   Total #  Security   In At   Current    Change
 04/17/98     337       EMAP    £11.998   £9.850  (17.90%)
 05/11/98     736       MKS      £5.604   £4.410  (21.30%)
 12/19/97    1565       RTO      £2.582   £3.360   30.14% 
 07/17/98     595       ULVR     £6.804   £5.160  (24.16%)


Last Rec'd   Total #  Security  In At     Value    Change
 04/17/98     337       EMAP  £4043.37  £3319.45 (£723.92)
 05/11/98     736       MKS   £4124.37  £3245.76 (£878.61)
 12/19/97    1565       RTO   £4040.63  £5258.40 £1217.77 
 07/17/98     595       ULVR  £4048.38  £3070.20 (£978.18)


Cash:               £67.82
Current Total:  £14,961.63