Restaurant royalty companies are a unique corner of the Canadian investment space. Rather than investing in the actual business of making and selling food, the holder of the shares gets a percentage off the top line of the underlying restaurant business. That makes these investments preferable to regular stocks in my opinion provided you can get them at a good price. I’ve previously talked about SIR Royalty Income Fund, but today I want to look at Pizza Pizza Royalty Corp. (TSE:PZA).
If you live in Ontario you are likely familiar with Pizza Pizza or if you are in Alberta then Pizza 73. These are the two restaurant brands of Pizza Pizza Royalty Corp. Pizza Pizza is pervasive in Ontario and has carved itself out a significant corner of the very large pizza market.
Looking at the 10 year chart of the stock you can see that PZA had a very steady rise, but has suffered a large fall in share price recently. Let’s take a look to see if this drop is justified. Looking at the 2017 annual report and 2018 second quarter results shows that after years of growth Pizza Pizza has had a hit to it’s revenue and earnings in 2017 and the first half of 2018. In the first half of 2018 sales are down 0.8% and same store sales are down 1.7%. However given that the share price has dropped from a high of around $18 to now about $8.50 for almost 53%, the drop seems to be an overreaction.
To come up with a target price for what I think Pizza Pizza is worth I’m going to take the earnings drop so far observed in 2018 of 2.56% and apply it to the earnings in 2017 to get an estimate of 2018 earnings. This comes to $0.845 per share. I used normal earnings rather than adjusted earnings as they are lower and should give a more conservative estimate of value. As mentioned on My Investment Philosophy page I think royalty companies are undervalued when they trade below 12.5 times earnings. This gives my estimate for Pizza Pizza Royalties worth of $10.56 per share vs. it’s current price of $8.53. This is a significant discount that you don’t get very often with these types of stocks.
One reason management gives for the recent drop in sales is the minimum wage hike in Ontario which caused them to raise prices. I don’t buy this reason, but I also don’t see any particular threat to Pizza Pizza that would cause them to go out of business. The pizza space is large enough for many players and I am sure that this recent drop in earnings is just a minor setback and earnings should continue to rise by at least inflation going forward.
Disclosure: I own shares of TSE:PZA