QUALIPORT
Qualiport Sells PizzaExpress

By Maynard Paton (TMFMayn)
November 18, 2002

The deed is done. Following Thursday's announcement, the Qualiport (notionally) sold its entire PizzaExpress (LSE: PIZ) holding on Friday morning. Less £15 for dealing costs, 644 shares at 340p raised £2,174.60. Today's article will finally wrap up the Qualiport's involvement with the restaurant group.

Story change

So why sell PizzaExpress? In short, the investment story has fundamentally changed.

One of the initial attractions to PizzaExpress was its operational simplicity. A general focus on the key pizza format and a limited menu had underpinned the company's success for the past thirty-odd years.

However, developments over recent years, culminating in September's annual results, clearly show PizzaExpress has lost its original charm. These days, as well as running the core UK & Ireland pizza chain, PizzaExpress is also developing Café Pasta, various international restaurant chains, Pizza To Go (fast food pizza), Gourmet Pizza (posh pizza) and Kettners (a plush London restaurant), all of which are at a fledgling roll-out stage. The preliminary results also revealed that "an examination of [more] acquisitions that could give us different formats that do not conflict with our existing brands" is on the cards, too.

To reiterate my earlier remarks, more formats, more menus, more ingredients, more trouble. As many other restaurant chains have proved in the past, too many cooks will spoil your investment. As well as additional formats, menu changes are also set for the core pizza chain. Greater choice, different size pizzas and even a children's menu are due soon. The operational simplicity is fast disappearing.

Why the change?

Why has PizzaExpress changed? In a word: enhanced competition. The Qualiport's biggest mistake with PizzaExpress has been underestimating the company's rivals. Although the aforementioned simplicity has played its part, the company's past success was also supported by a lack of meaningful competition.

In this interview, PizzaExpress chief executive David Page recounted: "There were no other similar corporate businesses until 1989, when Café Rouge started. There was either expensive foreign dining or cheap and cheerful cafes. PizzaExpress filled the gap."

During the 1990s, plenty of newcomers entered the 'casual dining' middle ground, most notably fellow pizzeria ASK Central (LSE: AKC). Quite simply, the changing menus, the new dining formats and extensive refurbishments at the core pizza chain are all signs the competition has caught up with PizzaExpress.

With Page admitting his company now faces "three or four very good competitors", plus the ever-increasing number of fast-food/dining alternatives, it's extremely unlikely PizzaExpress will ever generate the high margins and high returns of capital of yesteryear. Indeed, PizzaExpress did not present a 'five-year maturity table' (outlining expected profits at a typical new pizza restaurant in its first five years) during the latest results briefing, which suggests future profitability will not meet historic levels.

Valuation

But with the shares (at 350p) on a price to earnings ratio of 10, the shares are cheap, aren't they? Sure, there's a case for saying PizzaExpress is undervalued. But you could argue that Royal & Sun Alliance (LSE: RSA), Cable & Wireless (LSE: CW.) and Invensys (LSE: ISYS) are all cheap on certain 'value' grounds, too.

At the end of the day, price is one thing, business quality is another. As stated in the past, PizzaExpress could make for a rewarding medium-term recovery play. However, given the inherently tricky, fickle and increased competitive nature of the sector, it's not to hard to imagine a PizzaExpress revival followed quickly by another bout of trouble.

PizzaExpress has undoubtedly lost a two or three notches of quality over the past year. And hanging on just for 'value' isn't the way a long-term quality portfolio should operate. The Qualiport has been here in the past with MMT Computing. The company deteriorates, but the shares look cheap. The company deteriorates further, but the shares look cheaper still. And so it continues, until you realise the business quality has all but disappeared and the share price value was in fact a mirage.

Making it back

When MMT Computing was sold, I wrote: "Remember too, that you don't have to make it back the way you lost it. There are plenty of other companies out there that have more stable, predictable futures than MMT. More than likely, they'll deliver greater returns to shareholders in the future, too... What's more, maintaining a watchful eye on troublesome companies takes up valuable time."

Investors never have to make it back the way they lost it. There will always be opportunities to switch into more reliable companies at attractive valuations. However, a distraction in your portfolio will give you every chance to miss them. At the moment, companies such as Associated British Ports (LSE: ABP), London Stock Exchange (LSE: LSE) and Renishaw (LSE: RSW) are all hovering just above attractive valuations. These businesses will almost certainly provide greater long-term earnings predictability than PizzaExpress.

The Qualiport paid an average of 690p per share for PizzaExpress. And at the 340p disposal price, it's been a tough stock market lesson. Entirely my fault, though. I totally misjudged the company and its competitive 'franchise' (for what it was). A distinct lack of obvious and immediate value when judging the company's value ensured I paid far too much for the shares as well.

Lesson learnt. It's time to move on.

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