QUALIPORT
PizzaExpress: Keeping The Faith

By Maynard Paton (TMFMayn)
February 11, 2002

Carburton Street, London -- Qualiport company PizzaExpress (LSE: PIZ) published its interim figures this morning. The results contained two notable features:

* The departure of Ian Eldridge, the group's Chief Executive, and;
* A marked slowdown in like-for-like (LFL) trading.

Overall, the results showed nothing to suggest that PizzaExpress had lost its magic touch with diners. But boardroom changes and LFL sales growth of just 3% re-emphasised how important managerial talent and the health of consumer spending are to the restaurant group.

Here are today's half time numbers:

                               Six months to
                           31/12/01  31/12/00     Change
                              (£m)     (£m)         (%)

 Turnover                    103.8     89.5         16.0
 Operating Profit             21.4     19.5          9.7  
 Profit before tax            21.1     19.5          8.2 

 Earnings per share           21.5p    18.5p        16.2
 Dividend per share            2.5p     2.0p        25.0  

Boardroom

Whichever way you look at it, the resignation of Ian Eldridge from the PizzaExpress board cannot be taken as a positive. That's especially after Glen Tomlinson, the group's Finance Director, had already signalled his intention to leave PizzaExpress at the end of June.

Before his departure, Eldridge had spent the last ten years being responsible for all of the group's company-owned restaurants. David Page now leaves his executive Chairman role to become Chief Executive (again), with Page himself replaced by a new, non-executive Chairman.

During this morning's results presentation, Page remarked on Eldridges' departure. Apparently, it stemmed from appointing three senior managers to the boardroom a year ago, each of whom took on greater overall responsibility for various parts of the UK operation. With Eldridges' UK workload thus lightened, he was free to concentrate on overseas developments. But as Page admitted this morning, Eldridges' new role "did not fulfil his ambitions". With Page remaining as Chairman and the three boardroom newcomers apparently doing a very good job, Eldridge was essentially "squeezed out" of the company.

UK & Ireland Pizza

PizzaExpress can be broken down into four distinct operations: UK & Ireland Pizza, Café Pasta, International and Other. Here's how each division performed over the full year:

The two points to focus on with the core domestic pizza chain are LFL sales growth and restaurant numbers.

* In line with the comments made at the September full-year stage, LFL sales growth of +3% was registered during the period. This performance followed a somewhat buoyant 2000 when +10% LFL growth was reported. However, with the average spend per head up 8% during the last six months, customer numbers actually fell. But the deterioration was London-specific, with low tourist numbers and a downturn in financial and media sectors given the blame.

* PizzaExpress had 287 domestic pizza restaurants at the end of December and the number of potential pizza outlets remains at the "at least 500" level. There are also plenty of new restaurant opportunities. There were 14 new openings in the half-year ending December 2001, with 35 planned for the full year.

Café Pasta

The mainly London-based Café Pasta operation had a tough first half. LFL sales growth was -1% over the period (compared to +18% last year), although the second quarter figure was +4%. Café Pasta presently has 14 outlets in operation and the UK target remains "at least 100". Five new Café Pasta restaurants are planned for this calendar year.

International

Overseas restaurants remain a slow, uncertain and loss-making venture. Because of their continuing underperformance, the group's two US restaurants were shut during the interim period (creating a £0.7m exceptional charge). While another eleven franchised restaurants have opened since June, it's the company-owned outlets where the real potential lies.

Three company-owned restaurants opened in Spain during the period (taking the company's total to four), with the first French company-owned restaurant scheduled to open later this year. And while France and Spain appear to be the favoured international opportunities, the rollout process sensibly remains a cautious one. Indeed, when asked this morning about possible slip-ups the group could face, David Page remarked that international expansion would present the greatest opportunity for operational headaches.

Other

As well as traditional restaurants, PizzaExpress also generates income from supermarket pizzas. The group has started an embryonic fast-food Pizza To Go operation, too.

Although presently contributing to less than 5% of group profits, the future of PizzaExpress supermarket pizzas (which are made by a third party) remains bright. Alongside J Sainsbury (LSE: SBRY), PizzaExpress is looking to supply other supermarket chains later in the year.

The opening of a third Pizza To Go outlet is scheduled for April. While the early signs are encouraging, management remained non-committal in terms of the concept's financial prospects.

Summary

The major questions PizzaExpress shareholders have to ask are:

* Will the management departures have any long-term affect on the company?
* Can PizzaExpress revive its present lacklustre trade?

On the management front, the jury remains out. The departure of Tomlinson is not as concerning as Eldridge leaving, with the latter being instrumental in the successful running of the UK business. How the three 'replacement' restaurant directors (two of whom have been at PizzaExpress for over ten years) cope remains to be seen. While management skill is vital in the fickle restaurant sector, PizzaExpress has seen executive directors leave before (notably founder Peter Boizot), but has continued unharmed. That said, if David Page ever left PizzaExpress, serious shareholder questions would have to be asked.

With plenty of dreary trading statements emanating from other restaurant operators, it's unlikely that the current deterioration in London trade is due to PizzaExpress-specific problems. Overall LFL sales growth is currently around the 3-4% level, with ongoing sales growth in restaurants outside of London far exceeding the flat growth experienced in the capital. It's worth noting that during 1998 and 1999, when group LFL growth was 3% or less, various innovations helped LFL growth jump to 10% for 2000. Menu enhancements were touched upon at this morning's presentation, and it's a fair bet PizzaExpress will not sit on their laurels with regard to their latest performance.

Although there are niggles, the Qualiport remains a reasonably happy PizzaExpress shareholder. The group still has the real potential to double its UK restaurant estate, while international outlets, supermarket sales and Pizza To Go units all offer varying degrees of further profit potential.

Although suffering a slight decline (due to a 7% hike in labour costs), operating margins at PizzaExpress remain above the 20% mark. Furthermore, with £27m (38p per share) net cash in the bank plus a robust 17% incremental return on equity produced over the last five years, the accounts are in fine fettle.

At 807p per share, PizzaExpress is valued at 19.3 times trailing earnings per share. Although I'll be updating this valuation model in the near future, my present feeling is that PizzaExpress shares are some way from "good value" at the moment. Indeed, if the only change made to those earlier valuation calculations was to update number of UK pizza restaurants currently in operation, only a share price of under 700p would offer a possible 15% compound return over five years.

More: PizzaExpress: Full Year Results | Fool Values PizzaExpress