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Papa John's Delicious Margins      

by Louis Corrigan (TMF Seymor)

Atlanta, GA (May 4, 1999) -- Another full helping of stocks this week on our Rising Margins screen, including at least one tasty treat.

Although I've reached the point in my life when a pizza delivered to the door doesn't sound like a great dinner option, it's become a more compelling one since I discovered Papa John's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PZZA)") else Response.Write("(Nasdaq: PZZA)") end if %> about a year ago. By picking up more customers like me, this restaurant chain has been delivering earnings with extra toppings.

The 1,958 store Papa John's pizza empire has baked up terrific results while waging a very high profile war with Tricon's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: YUM)") else Response.Write("(NYSE: YUM)") end if %> Pizza Hut unit over exactly who's got the freshest ingredients and best-tasting pizza. The battle has become so intense because Papa John's has taken the pizza delivery business by storm.

After acquiring the Minneapolis Pizza Company, a franchisee running 37 stores, the company now owns 514 Papa John's restaurants and manages a franchise system with another 1,444 stores across the U.S. and in four international markets. Overall system revenues have grown from just $298 million in FY94 to $1,156 million last year (40.3% CAGR). The company's revenues have been cooking, too, rising from $162 million in FY94 to $670 million last year (42.7% CAGR). (The company collects a minimum of 4% royalties on its franchisees' sales.)

First-quarter revenue increased 20% to $187.4 million, sending net income up 52% to $11.4 million. EPS soared 48% to $0.37 from the $0.25 per share recorded a year ago before the cumulative effect of an accounting change. Systemwide comp-store sales increased 7.2%, with company-owned stores delivering 2.9% growth and franchised units reporting a 9.2% gain. Those increases come atop an 11% comp-store leap in the year-ago period and a 9% jump in Q1 FY97, suggesting that the concept has legs. The store base grew 4% in the quarter with the opening of 76 new units (73 by franchisees).

The company's Q1 press release is skimpy on financial information. A quick look at the recent 10-K, though, reveals a mid-cap company that's been doing just fine, thanks. The four-year compound annual growth rate for EPS has been 40.2%, or 42.9% before the effects of the accounting change. Last year, revenues shot up 31.6% with EPS leaping 37.4% to $1.25 (before the accounting change; $1.16 after) from $0.91 in FY97.

As the Fool Snapshot reveals, the company has no debt and about a dollar per share in cash as of December. The 10-K says it's also got just $12.5 million out in loans to franchisees, a very reasonable amount. Return on equity was a solid 15.9% last year. At around $40, the stock trades for 25 times this year's projected earnings of $1.61 per share and around 19 times the $2.06 estimate for FY 2000.

Figuring the company should deliver about 30% earnings growth for the next few years, it looks like a modest value today. Personally, though, I'd prefer to wait until the company offers a discount coupon. In mid-April, Papa John's touched $34, the lower end of the recent trading range. That's about 21 times forward estimates, which would be delicious. Definitely worth a closer look.

From pizza to pasta -- American Italian Pasta <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PLB)") else Response.Write("(NYSE: PLB)") end if %>, that is. The company is now the second largest North American producer of dry pasta, making Bestfoods' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BFO)") else Response.Write("(NYSE: BFO)") end if %> Mueller's pasta, among others. The company reported $189.4 million in sales for the fiscal year ending last September, with operating profits of $17.6 million.

The company has spent heavily on its cost-efficient, vertically integrated facilities, adding a new automated durum wheat mill in Columbia, South Carolina as part of an $86 million capital expenditure program that increased its production capacity by 90% to over 600 million pounds of pasta per year. Minimum annual purchases from Bestfoods will cover 60% of this added capacity. The company is now spending an additional $40 million so it can handle up to 800 million pounds per year. These new projects should be finished by the end of September.

March quarter results reflected the impact of the new Mueller's contract and lower durum wheat costs, allowing gross margins to increase despite 9% lower average selling prices. Revenues rose 21.4% to $56 million while EPS increased 30.4% to $0.30.

Thanks to Mueller's (which accounted for 28.4% of revenues), sales to the retail market soared 28%, or $8.8 million, accounting for most of the increased sales. Gross margins edged up to 25.8% from 24.1% while selling and marketing expenses dipped to 6.5% of sales from 6.8%, given that there were no such expenses connected to the Bestfoods deal. General and administrative expenses rose slightly to 2.8% of sales from 2.6%.

So American Italian Pasta enjoyed a terrific quarter with promises of further revenue gains to come as the company brings more capacity online and bids for other contracts. Selling for about $28, the stock trades for 22 times the
FY99 earnings estimate of $1.26 per share and 18 times the FY 2000 estimate of $1.54.

Yet, as the Fool Snapshot reveals, the company produced just a 12% return on equity (ROE) despite accumulating some $79 million in debt to finance its growth. Some of that reflects the fact that the company went public in October 1997 and used much of its new equity capital to retire debt. Still, this just points to the capital-intensive nature of the business, which suggests limits to the firm's potential operating leverage.

Although American Italian Pasta looks like a well-positioned player in its market niche, it's not an especially appetizing niche, despite growing consumption of pasta. I'd pass on this one.

Finally, one of our old margins friends, Craftmade International <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CRFT)") else Response.Write("(Nasdaq: CRFT)") end if %>, a small company engaged in the design, distribution, and marketing of ceiling fans, light kits, and accessories manufactured based on its designs. The company's outdoor lighting products are sold by Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %> and Lowe's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOW)") else Response.Write("(NYSE: LOW)") end if %>.

Thanks partly to the acquisition of lighting firm Trade Source International, Craftmade's Q3 sales increased 132% to $21.3 million, pumping up net income to $1.3 million, a 165% increase. EPS rose by an even stronger 143% to $0.17.
So trailing 12-month figures look like this: revenues of $73.6 million (up 79.9%), net income of $5.6 million (up 97.9%), and EPS of $0.77 (up 79.1%). Net margins stand at 7.63%, up from 6.94% for the twelve months ending in March 1998.

CEO James Ridings said the company is "on track to meet or exceed analysts' consensus estimates" of $0.93 for the year ending in June. The company is expected to earn $1.23 for FY 2000, as analysts are looking for 33% long-term growth. At $13 a share, the stock trades at just 14 times projected earnings less than two months away. The company's board no doubt thinks that's cheap. Back in March, when the stock traded for $14 3/4, the board authorized the repurchase of 200,000 shares, or 2.6% of the 7.6 million outstanding.

Turning to the Fool Snapshot, we see a company that used some long-term debt (about $5.7 million as of December) and some short-term credit to leverage its results, producing a 28.5% return on equity. The company also had $4.1 million in cash as of December.

Craftmade has been an outstanding performer, producing a four-bagger for investors who have held the stock for three years. If it can indeed deliver on the earnings projections, it represents a solid value. However, the company is dependent on the general health of the economy, particularly the housing market and interest rates. Rising rates since October have probably contributed to the contracting P/E. Of course, if you think rates will eventually trend lower, Craftmade could head quite a bit higher.
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