PizzaExpress - A Game of Chicken - Model Update

All,

Please find our updated analysis on PizzaExpress here.

UK consumer spending seemed to be turning a corner in summer, and back-to-school has gone well. However, casual dining does not seem to be on the menu quite yet, least of all, pizza. So while the chain is humming along quite smoothly again, what are the options from here?

Investment Rationale:

- We remain long and wrong the equity following PE's last restructuring in 2021. 

- We were beginning to like the bonds in Q1, but have turned less bullish since. Growth has gone the wrong way, and as a result, so has our EV to some extent. Instead of 'winging it' by introducing a 'Chicken Express' corner in its restaurants (or similar), management will rather go down with Pizza alone. We understand the rationale, but that doesn't mean we have to buy it.

- PizzaExpress (PEX) is a stable business (at these low levels), and it's already run as lean as its pizza. In a scenario where the company cannot raise sales idiosyncratically, some mild inflation (in revenue and cost) might help the company grow into this new bond. However, even 13% cash yield plus exit fee with no debt ahead cannot yet convince us to build a complementary position in the bonds before we see revenue growing again. 6% revenue growth (assuming stable expenses) are not unachievable, but affording itself the stubbornness of braving it out in Italian Casual Dining amounts to swimming against the tide with an equity type bet (bonds no longer EV covered on this trajectory) on top line growth in the worst hit segment. That's a directional bet, and PEX is not headed in the right direction.

- For PEX to make money for its bond- and shareholders, either the UK macro environment must shift, or Pizza Express, and both are headed south. It’s a game of Chicken, and we don't like it.

Per-Site Revenue:

- PEX (PizzaExpress) is too small now. Per-site revenue needs to grow (hasn’t since the pandemic) to refinance this capital structure. Italian Casual Dining is out of fashion, and Chicken is trending. Pizza Express is stable and reasonably profitable. But to refinance this balance sheet orderly, it must grow by at least £25m in revenue, or approx. 6% without further cost inflation. (Model). 

- Without a path to growth above inflation, achieving an EV above 5x is difficult, leaving EV insufficient to fully cover the debt on this trajectory (DCF).

The Problem:

- The company is stable and well managed, with lean operations and fair margins given the weak demand environment. Cash Flows are unlikely to move until demand improves. The problem is now the menu (Current Trading, Model).

- Italian Casual Dining is out of fashion. There are too many exciting new options, and Chicken is strongly on the rise. Opening the menu to Chicken now risks that PEX would have to do so again when the next fashion comes along. Still, Pizza Hut does it.

The Estate:

- The number of restaurants has been growing slightly, but we fear that next year NROs will be offset with further closures due to even lower demand than anticipated. Meanwhile, CapEx should rise with accelerated new openings (Model).

Looking forward to discussing this name with you,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk