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Comparing the financial performance of one company to another in the same industry can be quite difficult. Even with these two very similar pizza chains, there are a few pitfalls that investors need to be wary of.
PizzaExpress
Operating Margins
PizzaExpress
Although ASK have the greater revenue-producing restaurants, it appears the venues are commensurably more expensive. The average fixed asset value of an ASK outlet is £464,000 compared to the PizzaExpress average of £385,000. Comparing the sales that can be leveraged of each 100p of tangible asset, PizzaExpress is the better of the two in terms of effective capital expenditure.
Where ASK's historic equity return performance is identical to its incremental equity accomplishments, PizzaExpress' incremental figure slips to 20%. Even with an £8m chunk of goodwill for the non-contributing Café Pasta operation, and a far greater equity base, PizzaExpress still manage a creditable performance.
It's a close run thing. Just looking at the couple of ratios outlined above, there's nothing truly conclusive one way or the other. Although I'm perhaps slightly biased, I feel PizzaExpress shades the contest so far. Simply on a historical basis, the Qualiport favourite has proved it can manage 20%-plus margins and consistently produce superior equity returns over a longer timescale. Certainly, in terms of capital expenditure returns and ignoring the goodwill aspect, I feel PizzaExpress have historically had the upper hand.
"I hate PizzaExpress" Nigel declared, adding "I have been to their restaurants 10 or 12 times now and I have never (not once) come away feeling satisfied... With ASK Central, I have never, ever felt ripped off..."
But Marklucas1 retorted to Nigel's feature in this post, in which he comments:
"The analysis makes the basic mistake of mixing up personal likes and dislikes with investment appraisal. For example, personally I wouldn't be seen dead within a 100 yards of a McDonalds (NYSE: MCD), but over the years they have done wonders for their shareholders"
In these circumstances, I think Mark is correct. In weighing up the pros and cons of ASK and PizzaExpress, I'm not too bothered how big the pizzas are or my opinion of the table service.
Neither restaurant may be to my taste, but I'm happy to know that lots of other people appear to enjoy those types of venues and that the clientele do come back for more. But what I find more important are the underlying financials. It's no good ASK or PizzaExpress selling the greatest pizzas ever made with top-notch service, if the companies don't make any money.
Although an eye does have to be kept on the consistency of the dishes, when it comes to restaurants, I'm more interested in the performance from the accounts, not from the kitchen. I called PizzaExpress the doyen of its sector in the Motley Fool's Industry Focus 2000. Are ASK now ready to replace the Qualiport favourite and take the industry top step?
The Financials
Firstly, the two operations are at different stages of their expansion and so economies of scale will differ. ASK had 79 outlets at the start of the year, while PizzaExpress currently has well over 200. Secondly, the history of PizzaExpress has involved a franchising concept. In the past, the Qualiport member has had the benefit of franchising fees that fall straight to the bottom line, producing a favourable effect on operating margins. And thirdly, PizzaExpress eventually acquired the franchises and subsequently purchased the less than successful Café Pasta concept, both creating large goodwill write-offs.
Overall, the difficulties make for a subjective opinion of the financial performance, but I feel we can get a good grip on how the restaurant chains compare.
Ask Central
(to 31st December) 1995 1996 1997 1998 1999
Turnover (£k) 3,080 6,373 12,832 23,707 41,161
Operating Profit (£k) 215 684 1,849 3,852 7,052
Operating Margin (%) 7.0 10.7 14.4 16.2 17.1
Average number of 13.5 23.3 37.5 60.8
restaurants
Sales per average
restaurant (£k) 472 552 632 678
(to 30th June) 1995 1996 1997 1998 1999
Group Turnover (£m) 30.7 44.3 71.1 99.6 126.6
Operating Profit (£m) 6.2 9.1 14.8 22.1 29.1
Operating Margin (%) 20.2 20.5 20.8 22.2 23.0
Company restaurant
turnover (£m) 22.4 36.5 68.1 98.2 124.8
Average number of 39.3 58.6 105.9 152.4 201.2
company restaurants
Sales per average
company restaurant(£k)570 623 643 644 620
Looking at PizzaExpress' record, you can see how the turnover from company owned restaurants steadily reached the group turnover level, as the company gradually bought out its franchisees. The historic franchise royalty payments, without an associated cost, do distort PizzaExpress' operating margin record.
ASK managed operating margins of 17% during 1999 with an average of 60.75 restaurants in operation. Compare that with PizzaExpress' 1996/7 performance. Back then, between sixty and a hundred PizzaExpress restaurants managed a margin of 20%, of which royalty payments played a part. Can ASK eventually manage 20%-plus margins, or perhaps reach the 23% figure PizzaExpress produces today?
With larger economies of scale still to play a part in ASK's operating performance, there is still ample scope for them to raise their margins further. Of course, PizzaExpress have already set the "margin standard" and ASK still have to measure up.
Sales per restaurant
Quite disturbing for PizzaExpress fans are the sales per restaurant figures. Taking the average number of restaurants throughout each of the last four full financial years, ASK have impressively raised this number from £472,000 to £678,000. Of course, as ASK progressively rolls out its restaurants from the affluent London and South-East areas, and the sudden awareness of their new restaurants begins to fade, so the sales per restaurant figure should plateau. But still, the figures and the trend look far better than that of PizzaExpress.
PizzaExpress would argue that it can take up to five years for a restaurant reach its maximum sales potential, and having a large estate of restaurants under five years old, this undoubtedly impacts on their figures. But ASK Central have a similar "word-of-mouth" approach to their restaurants, and I'm sure a comparable maturity profile exists at the PizzaExpress rival.
Capital Expenditure
So ASK appears to have the better performing restaurants, in terms of revenues at least. But what about the costs to create the restaurants in the first place? It's one thing to have large dining revenues, but it's the return on the company's assets that really count.
For both restaurateurs, it's capital expenditure laid down today, in the form of property and fixtures and fittings, that generates the revenues of tomorrow. Although PizzaExpress has in the past purchased franchisees and the Café Pasta business, generating goodwill that could be interpreted as a proxy for capital expenditure, I've excluded these transactions from the following calculations. As there are just a handful of PizzaExpress franchisees left, and it's unlikely PizzaExpress will venture back onto the acquisition trail any time soon, I'm assuming both companies will generate further growth through tangible fixed asset spend only.
Comparing the revenue-generating effectiveness of the tangible fixed assets (TFA) utilised throughout the years gone by, and anticipating the future cost of expansion after determining the average value of each restaurant, could indicate the financially better-performing restaurant chain.
Ask Central
(to 31st December) 1995 1996 1997 1998 1999
Turnover (£k) 3,080 6,373 12,832 23,707 41,161
Tangible fixed
assets (£k) 215 684 1,849 3,852 7,052
Restaurants at
year end 10 17 30 50 79
Average restaurant
value (£k) 422 331 420 459 464
Sales per average
TFA (£k) 1.29 1.41 1.33 1.38
(to 30th June) 1995 1996 1997 1998 1999
Company restaurant 22.4 36.5 68.1 98.2 124.8
turnover (£m)
Tangible fixed
assets (£m) 6.2 9.1 14.8 22.1 29.1
Restaurants at
year end 47 74 138 183 220
Average restaurant
value (£k) 257 304 314 358 385
Sales per average
TFA (£m) 2.11 2.07 1.81 1.66
Looking at the turnover generated from the average tangible fixed assets utilised throughout the past few years, PizzaExpress have consistently outperformed ASK, generating 166p of sales for every 100p of fixed asset owned as opposed to ASK's 138p figure during 1999.
Rather than using historical revenue returns on fixed assets, perhaps a better guide to recent performance is the incremental calculation. With this in mind, ASK have increased their fixed asset base over the last five years by £32.4m to £36.7m and sales over the same period have risen by £38.1m to £41.1m. Dividing £38.1m by £32.4m leads to 117p of ASK sales per every 100p of fixed asset expense since 1995.
Over the same timescale, PizzaExpress have increased their fixed asset base by £72.6m to £84.7m, while sales have jumped £102.4m to reach £124.8m. All these figures lead to PizzaExpress leveraging 141p of sales per 100p of fixed asset spend since 1995. Looking forward to the future UK roll-out expenditure of both operators, it appears to me that PizzaExpress, with their cheaper and more efficient restaurants, will be by far the most effective.
Return on Equity
With a greater sales efficiency of fixed assets (fixed assets being by far the largest component of the balance sheet) and greater margins, PizzaExpress ought to have the greater return on equity. But with PizzaExpress saddled with £42.7m of purchased goodwill, it's a close call.
Adjusting for goodwill, PizzaExpress had average shareholders' funds of £95.5m during 1999. With profit after tax of £22.8m, the return on average adjusted equity is calculated at 23.9%. ASK managed to generate post-tax profits of £5.9m in 1999 from an average equity base of £24.6m, leading to a return on average adjusted equity of 24.1%. Even stevens, then.
Here are the figures for the five-year incremental return on equity calculations.
ASK PizzaExpress
1995 1999 Change 1995 1999 Change
Post-tax
profit (£m) 0.2 5.9 5.7 4.5 22.8 18.3
Adjusted year-
end equity (£m) 3.7 27.4 23.7 18.4 109.7 91.3
Incremental return
on equity (%) 24.1 20.0
Summary
But that's the past. What counts for an investor is the future. ASK, in terms of the number of restaurants, are one-third of the size of PizzaExpress. There's greater room for ASK to expand within the predictable UK backdrop. But that expansion will generate a lesser return than that seen by PizzaExpress, after it went through the same growth stage a few years ago. PizzaExpress should be able to nearly double its restaurant UK estate and produce similar equity returns to those seen in the past. But the real potential for PizzaExpress lies overseas. And of course, superior equity returns abroad can never be guaranteed.
After this cursory glance, there's nothing to suggest PizzaExpress is so far behind ASK in terms of past financial performance that a Qualiport re-think is required. In the very near future, I'll take another look at ASK and PizzaExpress, and their valuations. Meanwhile, your comments on this feature can be directed to the Qualiport discussion board.
Related Links
• ASK Central discussion board
• PizzaExpress discussion board
• Less is More
• PizzaExpress -- Very Foolish
• Motley Fool Industry Focus 2000
• Incremental Return on Equity