QUALIPORT
PizzaExpress Has Not Gone Ex-Growth

By Maynard Paton (TMFMayn)
June 24, 2002

Qualiport member PizzaExpress (LSE: PIZ) issued a trading statement today. The shares slumped 13% to 535p after the restaurant group reported a decline in like-for-like (LFL) sales growth. So what now for the portfolio's share holding?

PizzaExpress

The salient news from PizzaExpress was:

* Third quarter LFL sales growth of 1.5% was reported across the group's UK and Ireland pizza chain, with the second half (the six months to June 2002) expected to register an overall 1% LFL decline. LFL sales have therefore declined approximately 2.5% (so far) in the fourth quarter, and;

* Tough trading conditions continue in London, with a weakening of sales growth experienced outside the capital in the fourth quarter.

Points to take into account when considering today's announcement are:

* Difficult trading conditions in London were flagged last September: Prior to today's news, flat LFL sales had been witnessed in the capital. The performance was primarily caused by a reduction in tourist numbers plus the downturn in the financial and media sectors. The LFL decline in London during the fourth quarter is probably between 4-5%.

* A reliance on London: It's believed that 60% of PizzaExpress' profits are generated in the capital. Furthermore, half of London's contribution is said to come from just 20 restaurants. Of a PizzaExpress estate totalling nearly 300 sites, the capital has around 90 outlets.

* Slowing growth outside London: Before today's announcement, restaurants outside of London had continued to make headway. Comments describing 6% LFL sales growth outside of London were made in February. LFL growth in the fourth quarter is probably around 1-2%.

* Strong prior year comparisons: During the year to June 2001, LFL sales growth of 10% was recorded.

* Boardroom departures: Before his resignation in February, Chief Executive Ian Eldridge had spent the last ten years being responsible for all of the group's company-owned restaurants. In addition, Finance Director Glen Tomlinson left his executive role in March.

Is the game up?

What should investors make of today's news? Is the growth story over for PizzaExpress?

As many other companies have already testified, there has indeed been a reduction in tourists and workers in the capital. No doubt the Jubilee and the World Cup have dented recent trade, too. However, the departure of the experienced Mr Eldridge and the slowing of growth outside London do imply that something more fundamental may be amiss.

That said, it's important to note the strong LFL comparisons of the year before. During the first half of this financial year (the six months to December 2001), LFL sales grew at 3%. So the year to June 2002 will probably see overall LFL growth of 2%. Not a bad achievement, given LFL sales growth of 10% was reported the year before.

But it's the year to June 2003 that will concern investors at the moment. With no sight of an upturn in the important London trade, the deterioration of sales in the capital will have a disproportionate affect on profits.

For the year to June 2003, brokers had expected earnings per share (EPS) to increase 15% to around 47p. If EPS were to fall, say, 20% instead, the shares (at 535p) would offer a prospective earnings yield (effectively a free cash flow yield) of 6.2%. Unless profits dive even further and then never recover, the shares can hardly be seen as overvalued at present.

Advantage cash

The above valuation doesn't take into account the company's net cash position, which, at the end of December 2001, stood at £26.9m (38p per share). It's worth remembering that PizzaExpress is unique amongst quoted restaurateurs in having such a large pile of excess cash. This should prove to be a competitive advantage in the current dining climate. Indeed, PizzaExpress stated at its AGM in October 2001:

"We view any slow down in the UK economy as a potential opportunity.  In the restaurant sector more properties become available, rents become more competitive, building costs come down and we are seen as very good value as customers trade down from more expensive restaurants."

While the number of customers trading down may be unclear, there's certainly scope for PizzaExpress to capitalise from the current conditions. It will be interesting to see whether there's a notable increase in new openings over the next year or so. Also of interest will be whether the cash pile is used to fund a much mooted share buyback.

Buy, sell or hold?

Although today's news from PizzaExpress is disappointing, it doesn't undermine the company's long-term investment story. If tourists continue to stay away or London employers keep on cutting jobs, there's little PizzaExpress can do to compensate. This is, in the Qualiport's view, a temporary glitch. At the moment, there's nothing to suggest any permanent deterioration in the business has occurred. However, shareholders must remain vigilant. Some management niggles remain.

Sure, the next few results statements from the company may not be flattering. But the inherent qualities of PizzaExpress -- a simple, repeatable restaurant formula that requires limited capital and generates mountains of cash -- should remain. What's more, there's still scope for another 200-odd UK pizza restaurants and the potential from supermarket pizzas, Cafe Pasta and various international ventures too. PizzaExpress has not gone ex-growth and the Qualiport remains a shareholder.

More: PizzaExpress: Interim Results | PizzaExpress: Annual Results | Fool Averages Down On PizzaExpress

The author owns shares in PizzaExpress.