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With the reputation of PizzaExpress and their excellent trading record so far, these risks may all come to nothing. But then again, the risks may become all too apparent next year. Nobody really knows yet.
Consensus forecasts of earnings growth for this year and next year are around 19%. Although quite a strong rise is forecast by various brokers, it's below the historic 30%-plus rate seen in years gone by. No doubt the aforementioned risks have entered their calculations as well.
For a long term buy and hold portfolio, an essential characteristic of each company held must be future sales growth. And there has to be lots of it. A company can only increase profits so much by cutting costs. In the long run, it's increasing sales that counts.
To avoid any future claims of "sleaze" in subsequent features, the Qualiport writers have decided to declare Christmas gifts received from Alastair MacDonald, the Corporate Communications Director of Misys (LSE: MSY). Working for an IT company, Alastair chooses rather an odd present -- a Y2K Survival Kit -- for myself, Bruce Jackson and Rob Davies. Not only will the gift prepare us for a "major blackout" and help us to find "remote wilderness living areas", rather concerning is that the kit also allows us to "avoid the banking crash". Should we be selling Lloyds TSB (LSE: LLOY) instead of considering Rentokil and/or Unilever? Of course, it goes without saying that if we make it into next year unscathed, we won't be selling Misys. Definitely one to keep, I say... I've always liked Misys...
Bruce only mentioned PizzaExpress, but I've also noticed Independent Insurance Group (LSE: IIG) on a rather mean rating of late. Looking at recent consensus forecasts for their growth, perhaps it's worth revisiting them as an alternative to the PizzaExpress top-up. As for all the others, they all look on too high a rating for me. So, I'll just concentrate on PizzaExpress for the time being.
Is it worth buying PizzaExpress? As Bruce pointed out on Monday, there are three distinct risks with PizzaExpress:
But risks or no risks, I'm sure PizzaExpress, through their expansion, will be increasing sales and profits over the next few years. Basically, I'm counting on PizzaExpress to sustain their competitive advantage and appeal.
To me, the three risks outlined above affect the rate of PizzaExpress' future growth, rather than whether there will be any growth. So, it's just about estimating the profit growth, then...
There are two schools of thought to profit growth forecasting.
First, there is the detailed option. Here you can make a detailed study of various ratios, for example sales per restaurant. Then calculate group sales based on the expected restaurant roll-out using the ratios. Then make assumptions about future costs, capital expenditure and tax rates, to finally arrive at anticipated profits. (You may also wish to look at this great post from Mark Lucas on some specific PizzaExpress variables that go into such estimates.)
Then there is the simple option. You forecast forward earnings using a conservative earnings projection rate based on historical figures.
As someone who has not followed PizzaExpress in depth, in fact not at all, I'm going (ashamedly, perhaps?) to choose the latter option. Although it appears I'm taking the easy option, I always think back to what I wrote about Ben Graham's Margin of Safety a week or two ago.
However, investors without this specialised "lack of vision" aren't completely helpless. Graham makes this very important comment.
"the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future."
I have this "lack of vision" when determining exactly how fast PizzaExpress will grow. But I'm confident it will grow. Thus I'm going to place my faith in the Margin of Safety concept. That is, put simply, paying 50p now for something that has an anticipated value of 100p. If I'm only paying half of the anticipated value, then there should be plenty of room for error should my calculations prove to be optimistic.
This is PizzaExpress' record, taken from CD REFS.
Year to 1995 1996 1997 1998 1999 2000(e) 2001(e)
30th June
Normalised
Earnings 7.97p 11.9p 18.7p 24.8p 33.4p 39.8p 47.3p
Per Share
EPS Growth 34.4% 49.7% 56.8% 32.8% 34.6% 19.1% 18.7%
So what's my stab at a future growth rate, given I'm bullish on PizzaExpress? In previous features, Bruce has commented on at least 15% plus per annum growth. I'm not that optimistic. I'm going for 12.5% growth over the next few years.
So 12.5% earnings per share growth for the next six years gives earnings per share of 67.7p in 2005. On a fairly reasonable prospective earnings multiple of 20, that gives a prospective share price of 1354p five years out. With a dividend to earnings payout ratio of 20% throughout that time, I've added on 48p of accumulated dividends to get a total expected value of 1402p.
So when considering an investment in PizzaExpress, we have to weigh up the aforementioned risks with the price to be paid for the shares. To what extent do these growth rates factor in all the risks? Is 12.5% too pessimistic? I think it's a fair rate considering the risks and the historic precedent, but you never know. My feelings at this stage on admittedly rough calculations, and without any in-depth knowledge of the business, are that PizzaExpress at 725p do look attractively priced, but not at that real bargain basement level.
Moving on to selling.
It's this sales growth problem that is the concern with Unilever (LSE: ULVR) and Rentokil Initial (LSE: RTO). There just really isn't any significant growth in sales in sight. The sales decline has been well documented in previous Qualiport features.
Say Rentokil and Unilever remain in the Qualiport. I can imagine in a year's time the same old "no sales growth" groans being described in the Qualiport reports. Why should we stick with them? All the other Qualiport members have foreseeable growth opportunities.
My view is that both Unilever and Rentokil should be sold. I'm a firm believer in "concentrating your investment firepower" -- that is, focussing your money on the best investment opportunities. Less is more, so to speak. I feel the Qualiport needs to hold fewer companies and that essentially means making fewer, but financially larger decisions. Make a few, big decisions and make them count on the portfolios overall performance. Well, that's what I say.
If we are confident of our decision to top up on PizzaExpress, let's do it boldly! If we are confident of PizzaExpress' fortunes, and we're confident that it's priced attractively, why not make it one of the Qualiport's biggest holdings? The outlook for PizzaExpress far exceeds that of Unilever and Rentokil. So, my feelings are to sell Unilever and Rentokil and look to reinvest the proceeds into PizzaExpress.
However, I've always been a fan of one investment virtue -- patience (or is it procrastination?). Unilever and Rentokil, unless anything dramatic happens, can probably be sold anytime at prices seen today. I don't expect fireworks in either share price any time soon. But for PizzaExpress? My own gut feeling is to wait for possible bargain levels, say sub-650p, and top up significantly with the Unilever/Rentokil proceeds.
So in the meantime, is it just PizzaExpress who are the only suitable potential top-up? What about Independent Insurance? Or do you know of any alternative long term investments, that fit the Qualiport criteria and are priced fairly at the moment? If you do, then please let us know on the Qualiport message board.
And Finally...
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Company Change Bid DELL(US)-0.70 41.00 EMA +0.21 13.34 IIG -0.08 2.65 MSY -0.34 8.18 PIZ -0.10 7.10 RTO -0.05 2.28 ULVR 0.00 4.03 LLOY -0.05 7.60 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 22/04/99 542 Misys 5.57 8.18 46.7% 17/04/98 301 Emap 10.20 13.34 30.7% 27/10/98 1133 Indep Ins 2.60 2.65 1.9% 29/09/99 356 Lloyds TSB 7.56 7.60 0.6% 27/01/99 74 Dell (US) 44.63 41.00 (8.1%) 19/12/97 783 Rentokil 2.55 2.28 (10.6%) 04/11/98 245 Pizza Exp 7.93 7.10 (10.4%) 17/07/98 266 Unilever 7.53 4.03 (46.5%) Last Rec'd Total # Company In At Value Change 22/04/99 542 Misys 3065.85 4433.56 1367.72 17/04/98 301 Emap 3139.85 4015.34 875.50 27/10/98 1133 Indep Ins 2990.63 3002.45 11.90 29/09/99 356 Lloyds TSB 2723.20 2705.60 (17.60) 27/01/99 74 Dell (US) 2007.42 1838.79 (168.63) 04/11/98 245 Pizza Exp 1966.34 1739.50 (226.84) 19/12/97 783 Rentokil 2046.53 1785.24 (261.29) 17/07/98 266 Unilever 2052.00 1071.98 (980.02) Cash: £ 28.46 Current Total : £20,620.92 Total Invested: £20,184.62 Profit/(Loss) : £ 436.30 Value Per Share Day Month Year Qualiport -1.55% 3.54% -2.36% FTSE 100 -1.02% 0.55% 12.77% FTSE All Share -1.00% 0.67% 16.22%