Qualiport

[ September 28, 2000 ]

Revaluing PizzaExpress

By Maynard Paton (TMFMayn)

Carburton Street, London -- Qualiport favourite PizzaExpress (LSE: PIZ) reported its full year results at the beginning of September. I gave my immediate reaction to the numbers in this Fool's Eye View.

Back in April, I set a 660p share price "Qualiport buy target" for PizzaExpress. Given that an improved full-year profit performance has since passed and PizzaExpress shares are currently at 645p, I think it's time to revisit the previous company valuation.

The nature of PizzaExpress' business lends a certain amount of simplicity to valuation matters. Estimate the number of restaurants operating in the future and their profitability, and you've got the foundation for the prospective worth of the company.

Now, I'm pretty wary of extrapolating any company's performance far into the future. I'm very much a fan of "obvious" value techniques, using price to earnings (P/E) or dividend yields for instance.

But even with my caution for projecting profits into the years ahead, it's still a very interesting exercise to calculate what could, on a conservative basis, happen at PizzaExpress. Does the current 645p share price offer a suitable margin of safety and an attractive investment return?

Tweaking the assumptions

After the recent results, I think we have to reconsider some of my original valuation assumptions. As a refresher, you may wish to read the original valuation article first, before I jump straight into my alterations.

Firstly, the rate of expansion in the UK. PizzaExpress declared in its full-year results presentation during September 1999 "at least 35 new PizzaExpress units [to open] per annum to 2004". In the year to 30 June 2000, 32 new PizzaExpress restaurants opened. The 2000 annual statement highlights the fact that the company "will open around 30 new PizzaExpress restaurants in the UK and Ireland during the financial year to 30 June 2001".

So I'll revise my original 35 UK pizza openings a year to just 30.

Pizza maturity

PizzaExpress kindly informed shareholders last year of the "maturity profile" of a typical new pizza restaurant. Their expectations are shown in the table below.

Year    Profit before Tax    Sales
              (£k)           (£k)

1              70             500
2              90             540
3             125             595
4             150             655
5             180             720

In the latest results, PizzaExpress mentioned that "the 32 new pizza restaurants opened during the year generated £6.5m of turnover and a profit margin (before opening costs of £0.5m) of 10%". On the face of it, this performance appears to make the above "maturity" table (that suggests a first year profit margin of 14%) a little optimistic.

However, the 32 pizza restaurants opened in the past financial year were very much weighted towards the second half of the year. And with those second-half restaurants still not up to an optimum first year speed, I'll continue to use the original table maturity as before.

So, the 30 outlets per year rollout and the above profit model combine to make the following projection.

Year of     Number of    Profit before     Total PBT
opening    restaurants   tax (£k)          (£m)
                                             
Pre 2001       243          180            43.7
2001            30          180             5.4
2002            30          150             4.5
2003            30          125             3.8
2004            30           90             2.7
2005            30           70             2.1

Total                                      62.2

The projection shows that during 2005, the company should have 393 pizza outlets open and prospective profits before tax of £62.2m. Again, as in the previous stab at the company's valuation, I'll assume a 25% tax charge (22% in 2000), a yearly dividend payout of 25% (18% in 2000) and a prospective P/E of 17. This P/E will encompass the stock market expectation of at least another 50 UK pizza restaurants to be opened after 2005 and, as we'll see, the promise of international expansion.

All in all, these figures equate to a 2005 market capitalisation of £793m, and with dividends of £44.8m collected along the way, the total valuation of the pizza business comes to £837.8m.

Pasta enters the equation

My previous PizzaExpress valuation applied a zero value for the company's Café Pasta operation. Back then, it was a loss-making operation without much sign of a forthcoming profit. The latest results revealed that the 13 Pasta outlets are now making a profit and that a rollout of this secondary dining concept is now under way. This being the case, it makes sense to now incorporate the Pasta chain into a prospective group valuation.

Here are my two simple assumptions for Café Pasta:

• There'll be 50 pasta restaurants operating in 2005
• A pasta restaurant will generate 75% of the profits of a typical pizza outlet

Using the average of the expected profit contributions from the pizza "maturity" table above, my 75% assumption equates to each of the 50 pasta outlets generating an average of £90,000 pre-tax profit in 2005.

Multiply the £90,000 by the 50 Café Pasta restaurants and pre-tax profits for the pasta chain of £4.5m are generated. Tax this figure by 25% and we arrive at anticipated pasta earnings of £3.38m. Place this profit on a P/E of 20 (given "the next PizzaExpress" potential) and we arrive at a total pasta valuation of £67.5m anticipated for 2005.

International

The latest results commented upon how the start-up costs of company-owned international restaurants would continue to offset profits created by the existing overseas franchise arrangements. This being the case, and given that the overseas expansion appears to be going a little slower than had been expected, I'm not going to spend too much time in calculating an anticipated international value. Quite simply, any market expectation of foreign profits should be encompassed by having earlier placed the core UK pizza operation on a P/E of 17.

Putting it all together

Add together the £837.8m (1209p per share) pizza valuation and the £67.5m (97p per share) pasta valuation and we arrive at a total group market value, anticipated for 2005, of £905.3m (1306p per share).

To arrive at a 15% investment return over the next five years, the entry price comes to 650p, 10p lower than that calculated in April.

Overall, I suspect the slight profit slowdown from the UK and international rollouts has offset the enticing developments at Café Pasta. Hence the PizzaExpress share price, similarly to my "buy price", has remained static over the past year or so.

Nevertheless, especially given the current 10% like-for-like sales growth performance, PizzaExpress shares at 645p remain attractive for a Qualiport top-up.

Where Next?

PizzaExpress Impresses
The Value of Pizza