Qualiport

[ July 28, 1999 ]

Pizza Bears & Bulls

By Bruce Jackson (TMFgoogly@aol.com)

Baker Street, London -- Shares in PizzaExpress (LSE: PIZ) continue to be weak. Whilst catching up on my reading, I saw a piece in last Friday's Investors Chronicle on them titled "Restaurant chain no longer flavour of the month." The bears say that the pasta chain, now labelled Café Pasta, is struggling and that the newer pizza restaurants are maturing faster than they used to.

Like for like sales growth has traditionally been a strong point for the company, especially in restaurants open for 3 years or more. This flies in the face of traditional restaurant business. Many companies in the sector find it difficult to beat their first year's sales, because of the excitement and promotion usually surrounding a new opening. For example, a mistaken investment in US theme restaurant company Rainforest Café (NASDAQ: RAIN) taught me many lessons about this. In their most recently reported figures, second quarter sales fell 11% on a like for like basis. Ouch.

Like for like restaurant sales figures usually give you an idea for the sustainability of a concept. Having eaten at the London Piccadilly branch of Rainforest Café, I'm not surprised that the company is struggling. I've never been back since, and don't ever plan to do so. PizzaExpress is very different. I enjoy the food and the atmosphere -- "the experience" -- and keep going back for more.

The PizzaExpress bulls point to the fact that the UK market should be able to accommodate up to 450 pizza outlets, up from 200 at the beginning on 1999. At a rate of 30-40 new restaurants per year, that leaves another 7 years' growth in new openings, plus the profits from the existing outlets.

The international strategy and its impact on the company is the great unknown. Can PizzaExpress be an international brand? Will the concept travel? There's no real great magic to PizzaExpress -- in theory, the restaurants can be relatively easily replicated. But, that's where the brand strength comes into play. In the UK, they are synonymous with trendy pizza eaters, and dominate the upmarket end of the industry. ITs -- part of Ask Central (LSE: AKC) -- is attempting to follow in their footsteps, but they are a long way behind in terms of number of outlets, but more importantly in the development of the brand name. Have you heard of ITs? I have, and I've eaten in their restaurants, which were quite good, but PizzaExpress still gets my vote.

The biggest challenge facing PizzaExpress, when they expand abroad, is building that brand name. They won't have the early lead like they've got in this country, and could end up being the ITs of India, Russia and wherever else they are going. It will be an interesting time for this quality company, and although the share price won't provide us with huge amounts of short-term excitement, we're happy to be long term part owners of PizzaExpress.

On Monday, I promised to have a deeper look at Misys' (LSE: MSY) current valuation. At this stage, I've only seen a preliminary results announcement, which although very comprehensive, lacks a few important numbers. I'll have to wait for the publication of the annual report before feeling totally comfortable in placing a valuation on Misys. However, since the initial buy report back in April this year, on the earnings side, nothing much has really changed. This is because Misys reported results largely in line with market expectations as they stood back then. So, if they can keep growing at 18% per annum for the next 10 years -- no easy feat, mind you -- we should see a return of over 15% per annum, compounding.

The one thing that was a little disappointing, although I was no doubt too optimistic in my original forecasts, was their cash generation. Let me clarify by what I mean by disappointing -- free cash flow didn't grow from 1998 to 1999. The apparent shortfall comes about because of 1998's massive £27.2m increase in deferred income. In 1999, that number fell year on year, although they still have £112m invoiced to customers but not yet recognised as revenue. This effectively gives Misys a very visible forward revenue stream, although clearly not as visible as at the 1998 year end.

On an updated discounted cash flow (DCF) model, I estimate the intrinsic value of the shares is about 570p each. That's a rather small margin of error, but nevertheless above their current price of 540p. This differs from my original DCF calculation because of a higher number of shares now in issue, and the zero year on year growth in free cashflow. However, in other respects I may end up being too conservative -- being an accountant and all -- so I have to balance that in my own mind.

The upshot of all this is:

1. I still have to plough through the Misys preliminary results release.
2. At 540p I can't see myself topping up on the Qualiport's existing holding. If the margin of safety were to increase, however, I wouldn't rule this possibility out.
3. Misys still look like a great company, with excellent long term prospects.
4. Valuation spreadsheets are only as good as the information you input into them.
5. Long-term valuation assumptions can go awry.
   

Rob's back on Friday. He's still got little idea of what Misys actually do, and this is also a weakness with my understanding of the company. In the meantime, all comments as usual are encouraged on the Motley Fool Qualiport message board, or on the boards of the individual companies.

Qualiport Numbers
28/7/1999 Close

Company  Change    Bid
DELL(US)+2.00    42.00
EMA     -0.04    11.41
IIG      0.00     2.98
MSY     +0.01     5.39
PIZ      0.00     7.40
RTO     -0.03     2.40
 ULVR    -0.03     5.79


Qualiport Stocks

Last Rec'd  Total # Company    Buy  Current Change
 27/10/98   755     Indep Ins  2.58  2.98    15.5%
 17/04/98   169     EMAP      11.34 11.41     0.6%
 19/12/97   783     Rentokil   2.55  2.40    (5.9%)
 27/01/99    74     Dell (US) 44.63 42.00    (5.9%)
 22/04/99   347     Misys      5.76  5.39    (6.4%) 
 04/11/98   245     Pizza Exp  7.93  7.40    (6.6%)
 17/07/98   266     Unilever   7.53  5.79   (23.1%)

Last Rec'd  Total # Company     In At  Value   Change
 27/10/98   755     Indep Ins  1972.64 2249.90  277.26
 17/04/98   169     EMAP       2341.32 2304.82  (36.50)
 27/01/99    74     Dell (US)  2007.42 1883.64 (123.78)
 04/11/98   245     Pizza Exp  1966.34 1813.00 (153.34)
 22/04/99   347     Misys      2028.71 1870.33 (158.38)
 19/12/97   783     Rentokil   2046.53 1879.20 (167.33)
 17/07/98   266     Unilever   2052.00 1540.14 (511.86)

Cash:                                       £3,371.66
Current Total :                            £16,912.69

Total Invested:                            £18,184.62
Profit/(Loss) :                            (£1,271.93) 

Value Per Share

                    Day      Month      Year      
Qualiport          0.32%    -0.94%    -10.07%
FTSE 100           0.55%    -0.34%      7.05%
FTSE All Share     0.48%     0.14%     10.34%