PizzaExpress - Picking Slim - Model Update - Positioning
All,
Please find our updated analysis on PizzaExpress here.
Note: Beta testers can check PizzaExpress on the Beta portal here.
One swallow does not a spring make, or so goes the saying. If H126 is that swallow, we might still be early to be betting on the spring. Next year's comps will be tough, and Mr. Burnham is unlikely to lower taxes, NLW, or business rates. But looking across the spectrum, 11% YTW for 66% LTV (no assets here) and marginal interest coverage is not all bad. Profits are slim, and the pizza is slimmer, but pizza requires less Ozempic than burgers or Wagamama. Not quite Chicken, but perhaps a reason to return to an old national favourite.
Investment Rationale
We remain long and wrong the equity following PE's last restructuring in 2021. We did not see the cost of living crisis coming. Illiquid as it is, we are not selling our equity now, just as the chain seems to be turning a corner. But we find ourselves sceptical that the £500m price tag can be achieved. If it can, we will be making good money on the name, even if late.
We are adding a 5% of NAV position in the SSNs to our existing ~1% in the equity. The SSNs are easily EV covered and, with a YTW of over 11%, are attractive.
We are risking a reversion of the recent growth in revenue, which might drive yields by 2% and drop prices by -4 points, a drop we hope to have earned in coupon by January. But much of the recently produced performance comes from aggressive cost cutting, rather than revenue, and the company can just about cover its interest. Leverage is about 66% of EV, and we can't imagine the shareholders entering a big fight over trimming this bond, when the 2025 transaction showed how to right-size the balance sheet.
If the company is sold (current process underway), then the bonds benefit from a standard CoC clause + a likely 1% exit fee. Technically, both could be waived if the selling shareholders still command large enough a majority within the bonds (possibly), but at least as regards the CoC, the coupon is too high to preserve aggressively.
Key Conclusions
Trading has inflected, with dine-in turning positive in Q1 2026 and Group LFL growth of 3.8% after a prolonged contraction. Revenue is now ahead of our forecast, although growth is driven mainly by volume rather than the more profitable price increases. (Current Trading)
Cost-cutting delivery remains strong, with recent quarters outperforming our model on productivity and lower central overheads, absorbing (slow) post-CVA rent reversion, business rates and NLW inflation. Management is executing well, and operations are lean; the fundamental issue remains the menu and the category in which the business operates. (Current Trading, Model)
Free cash flow remains thin following the refinancing, with the 9.875% coupon on the £280m September 2029 Notes keeping net interest broadly unchanged. To refinance the balance sheet orderly, the business needs at least £20m of additional revenue, or c.5%, without further cost inflation. (Current Trading, Model)
We consider our three-year outlook conservative at just under two new sites per year and 1.5% revenue growth, particularly given the severe headwinds facing UK Italian casual dining. The estate attrition has halted, and recent trading has improved, but lower per-site revenue limits the benefit from further expansion. (Driver, Model)
UK Italian casual dining is structurally shrinking as consumers move towards more varied options, including chicken, while the broader casual dining sector faces persistent cost inflation, higher NLW and rising business rates. The structural squeeze remains unresolved. (Industry, Driver)
The recent trading improvement therefore needs to be distinguished from the underlying category challenge. Pizza Express is stable and reasonably profitable, but per-site revenue is now too low; management’s operational execution cannot easily overcome a menu and segment that remain out of favour. (Model, Industry)
On assumptions closer to those of restaurant chains not anchored to a declining segment, and supported by the improvement seen over the last six months, we arrive at industry-standard valuations. The company is being offered for £500m, however, which is almost 20% above our DCF and is not supported by our operating assumptions. The £500m asking price therefore looks rich relative to our DCF, although our analysis still indicates equity value at a lower valuation. Shareholders may be willing to pursue a sale at a lower price, particularly if in their eyes the recent trading improvement can't be sustained. (Valuation)
Q226
The company has been put up for sale in a widely publicised process that seems to attract attention. Rothschild is acting for the shareholders to find a buyer above £500m, a price tag 20% above where we estimate EV and 40% above any form of implied equity ticket.
Group revenue of £111.5m landed essentially in line with our forecast of £112m, held up by UK & Ireland at £103.5m (+£4.6m) on UKI LFL of +4.1%. The quarter decelerated from Q1's +4.9%, and the composition changed: UKI dine-in LFL covers turned negative again at (1.5%), with the entire dine-in gain now coming from ASPH of +5.7%. The volume-led read we took from Q1 did not carry forward, so the top line is once more price-driven. As we have said, this is the shortest way to making this company refinanceable, but considering PEX' competitive positioning and the scant pizza in the first place, there is only so much room for price growth.
International revenue fell £1.1m to £8.0m on LFL of (5.8%), extending the Q1 reversal we pinned on the Middle East conflict, which is continuing. Management put the standalone-quarter International EBITDA drop at c.£0.9m, so the drag persists into Q2 rather than being a one-off, but at under 8% of group it remains immaterial to the credit; the only read-through is that the modest International tailwind we had expected in is gone for the year.
Q226 EBITDA was £12.5m against £10.8m a year earlier, a touch ahead of our c.£12m, with margin at 11.2% from 10.0%. The gain was entirely UKI (+£2.6m to £12.2m), driven by gross margin - up 230bp to 49.0% - and productivity, more than offsetting the tightly managed cost-of-sales labour inflation, where the company is holding back over £4m of NLW inflation. Cost savings delivery continues to run to plan and remains the engine of every earnings beat here; demand is still soft.
Resulting balance sheet cash of £9.5m was again right on target. The Q1 £7.5m RCF draw was fully repaid in Q2, leaving the £30m facility entirely undrawn and available.
H1 confirms the pattern we have tracked for a year: revenue up £8.0m to £223.6m, house EBITDA up £4.4m to £24.3m, but the £13.9m February coupon on the £280m September 2029 Notes and the year-end working-capital unwind (£16.7m) took closing cash from £29.1m to £9.5m. The 9.875% coupon keeps free cash flow thin, as the smaller facility carries a higher coupon.
Here to discuss this name with you,
Wolfgang
T: +44 203 744 7003
www.sarria.co.uk