Qualiport

More goals for PizzaExpress

By Bruce Jackson (TMF Googly)

Melbourne, Australia -- Monday saw yet another fine set of interim results from our international food retailer PizzaExpress (PIZ). The consistency of this company in the six years since it reversed into Star Computer has been outstanding. Consistent sales, margins and earnings growth is something we look for in a Qualiport company. PizzaExpress fits that bill and is growing well above average to boot. As we look at what I see as the highlights of the 6 month period to the end of December, remember that if we can find good companies showing sustainable growth of 15% per annum, we reckon we're doing well.

Sales up 28%
Operating Margin up to 22.1%, from 19.7%
Pre Tax Profits up 40%
Fully Diluted EPS up 45% to 14.9p
Interim Dividend up 24%

These are truly outstanding numbers, from top to bottom. The operating margin, at 22.1%, is amazingly high. This usually indicates that a company has a competitive advantage. If you think about the economics of the restaurant industry, it is characterised by intense competition and low barriers to entry. When walking down the High Street, take a look at the many eating establishments vying for your business. That PizzaExpress has performed so well in such an environment is a tribute to their management and simple formula, and the "experience."

PizzaExpress now have over 200 restaurants open, the vast majority of them being in the UK, in the south east region. Internationally, PizzaExpress already have franchises operating in places such as Cyprus, Egypt, France, India, Russia and Turkey. Countries such as Pakistan, Kuwait, Malta and South Africa are also earmarked for PizzaExpress restaurants. The company is being relatively cautious on this front but also a little innovative. It's hard to imagine the concept successfully travelling to some of the countries mentioned above, but if I'd seen USA and Italy on their list, that's when I'd get really worried.

PizzaExpress continue to kick goals. They are using a formula that has served them well since 1965, when the first Soho restaurant was opened. Importantly, like for like sales growth for the six month period was positive, at 3%, albeit less than they've reported in previous periods. Undoubtedly PizzaExpress will be affected by the downturn in consumer confidence -- we have already seen a lowering of like for like sales growth. However, there are still opportunities for further expansion. Another 15 pizza restaurant openings are planned for the second half of the financial year. Café Pasta, a recent acquisition, is so far not making any significant contributions to profits, and this state of affairs will continue for the short term whilst the management refine the formula before rolling out the concept across the country.

Now the downside. PizzaExpress have been pulled up in the past for their lack of adherence to corporate governance regulations. They have since added some non-executive directors to their board and now follow best practise as per the Greenbury report recommendations. However, as far as financial numbers go, their interim report leaves out important information. Whilst they are complying with the regulations as set out, they are providing the minimum information.

The accounts of any company do not give you the full picture unless they have a profit and loss statement, a balance sheet and a cash flow statement. Accountancy is perceived as being very precise and regimented art, but that is far from the truth. Whilst there are rules that must be followed, the interpretation of them is often open to debate. The profit and loss statement can be legitimately manipulated to give a wide range of potential bottom line results. When you consider that the all important earnings per share (EPS) number drops out from the profit and loss statement, you can see that the Finance Director of a company wields enormous power. A company releasing a shock profit warning, or results they know will be below market expectations, is not doing so lightly.

PizzaExpress' interim results didn't have a cash flow statement to accompany them. Out of the three financial statements, cash flow is the only one that can't be manipulated. Cash is cash is cash -- the bank balance never lies. The cashflow statement lets the share analyst check to see that reported profits are being translated into cash. If they are not, it could be that reported profits are being overstated. If, on the other hand, cash generation exceeds reported profits, you could well be looking at a very good company. Dell Computer Corporation (Nasdaq: DELL) is the master at this efficient financial operating model.

So, for PizzaExpress, we don't exactly know whether their excellent accounting earnings were translated fully into cash. The balance sheet shows that debtors and stock levels remain low, which is reassuring. These so called assets can tie up a lot of valuable cash. Sometimes sales that have been booked to the profit and loss account can end up going bad, and this will hit profits in future periods. Stocks on the balance sheet are one thing, but if you can't sell them, they are worthless.

Creditors on the balance sheet are usually made up largely of unpaid bills. These may include money owed to suppliers and the taxman, dividends declared but not yet paid and staff costs that have been incurred but not yet paid. By delaying payments to its creditors, a company has use of valuable cash for that much longer. "Buy on credit and sell for cash" ought to be the motto for every business, no matter its size.

PizzaExpress' creditors have reduced since the date of the last balance sheet, indicating that they may be paying suppliers a little quicker than they have in the past or that they have released profit boosting provisions to the profit and loss account. Without going into any more boring accounting detail, neither of these scenarios is absolutely ideal. We want to see creditors on the increase, as this means the company has the use of more and more cash. Without the cash flow statement, and the notes to the balance sheet, we can't be sure as to the cause of this reduction. I'm going to note it but not get too worried about it.

PizzaExpress now have trailing fully diluted EPS of 30.9p. With a share price of around 750p, that leaves them trading on a trailing P/E of 24. There are few companies as consistent and simple to understand as PizzaExpress, and the Qualiport is happy with the company's progress. As for the performance of the share price, we can't legislate for that. Over the long term, if the company keeps growing earnings at an above average rate, the share price will surely follow higher. The days of 1997 when the shares traded on an average P/E of 45 are gone, but arguably the company deserves to traded on an above average market rating.

Two final points.

-- Operating margins for the last three half year periods have been 19.7%, 25.3% and now 22.1%.
-- Restaurants less than one year old currently have an operating margin of about 10%.

Qualiwatch

We'll have an extended look at Glaxo Wellcome's (GLXO) valuation on Friday. Whilst the accounts themselves are very clear and well presented, to me the numbers just don't give that good gut feeling that I keep talking about. At this stage, I'm thinking we may have to be very patient if we are ever to pick up shares in the pharmaceutical giant.

Thoughts, as ever, to the Qualiport message board. Did you know that all the UK quoted Qualiport companies also have their own individual message boards? See you there.

                    09/02/99 Close

                   Company   Change    Bid
                     DELL    +$3.75  $104.00 
                     EMA      -0.19    11.92
                     IIG       0.00     2.31 
                     MKS      +0.01     3.60
                     PIZ      -0.24     7.18 
                     RTO      -0.10     4.34
                     ULVR     -0.14     5.44

Qualiport Stocks

Last Rec'd Total # Company  In At  Current  Change
 19/12/97   783      RTO      2.55    4.34   70.2%
 27/01/99    37      DELL   $89.25 $104.00   16.5%
 17/04/98   169      EMA     11.85   11.92    0.6%
 04/11/98   245      PIZ      7.93    7.18   (9.4%)
 27/10/98   755      IIG      2.58    2.31  (10.5%)
 17/07/98   298      ULVR     6.72    5.44  (19.0%)
 11/05/98   368      MKS      5.54    3.60  (35.0%)

Last Rec'd Total # Company  In At    Value     Change
 19/12/97   783      RTO   2046.53  3398.22   1351.69
 27/01/99    37      DELL  2007.42  2332.12    324.70
 17/04/98   169      EMA   2052.57  2014.48    (38.09)
 04/11/98   245      PIZ   1966.34  1759.10   (207.24)
 27/10/98   755      IIG   1972.64  1744.05   (228.59)
 17/07/98   298      ULVR  2052.54  1621.12   (431.42)
 11/05/98   368      MKS   2054.11  1324.80   (729.31)


Cash:                             £2,000.18
Current Total :                  £16,194.07

Total Invested:                  £16,184.62
Profit/(Loss) :                     £  9.45


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Qualiport         -0.75%    -1.83%     -3.66%
FTSE 100          -0.94%    -1.97%     -1.75%
FTSE All Share    -0.82%    -0.94%     -0.12%

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