Papa John's Has More Problems Than Just Its Founder

Papa John's International (NASDAQ: PZZA) tried to place the blame for the pizzeria's terrible second-quarter earnings report on founder, ex-CEO, and former board Chairman John Schnatter, who resigned last month following publication of comments that were taken as racially insensitive.

CEO Steve Ritchie said in a conference call with analysts that the pizzeria's woes go all the way back to last year, when Schnatter blamed the National Football League's handling of player protests for the pizza joint's lackluster sales. Papa John's was the NFL's official pizza sponsor at the time, a position it gave up earlier this year.

However, as Schnatter noted in a statement he put out following the earnings release, Papa John's International's deteriorating condition predates either of these controversies, as same-store sales began falling in mid-2016, which he attributes to Ritchie's appointment as president.

"Today's results highlight the further deterioration of Papa John's financial performance under the tenure of Steve Ritchie ... the company is trying to deflect attention from the source of the problem -- management's ongoing failures with regard to financial performance -- and blame me for its problems."

Perhaps, but Schnatter was still running the company during that period, so there is plenty of blame to go around. Papa John's was already falling behind the competition; Schnatter's controversies hastened the erosion.

Pizza is a hot business for some

The market researchers at Technomic point out that competition in the pizza industry is particularly intense because consumers are eating pizza more frequently. Limited-service pizzerias saw sales rise 3.7% in 2017, with increasing numbers of fast-casual pizza parlors, regional pizzerias, and other restaurants serving up more pies.

Coupled with the continued dominance by Domino's (NYSE: DPZ) in the quick-serve market, we see why both Papa John's International and Yum! Brands' (NYSE: YUM) Pizza Hut are struggling.

Revenues at Domino's domestic restaurants rose 12% last year, with comparable-store sales 7.7% higher. Over the first six months of 2018, sales and comps are 7.4% and 9.5% higher, respectively. Internationally, Domino's has seen comps rise for an astounding 98 consecutive quarters; they've risen "only" 29 straight quarters here at home.

In contrast, Papa John's saw sales rise 0.5% on a 0.1% increase in comps last year, while Pizza Hut revenues were up 2% and comps were flat. Things obviously haven't changed for the better with Papa John's this year, and Pizza Hut sales are up only 1% over the first six months, while there's been no meaningful gain in comps.

Giving some credence to Schnatter's complaint, over the past three years, Papa John's has spent a lot of money on buying back its stock, more than $450 million, money that helped prop up its earnings, but that might have been money better spent fixing its business.

Do it like Domino's

Domino's industry leadership isn't surprising. Former CEO Patrick Doyle engineered a remarkable turnaround for the brand in recent years, first taking the unusual tack of admitting his company's pizza sucked and then overhauling the company's recipe. In the process, it became the world's largest pizza chain by revenues, edging out Pizza Hut for the title.

According to Brand Keys Customer Loyalty Engagement Index, Domino's also remains America's favorite pizza brand in 2018, with Papa Murphy's second, Pizza Hut third, and Little Caesars fourth. Papa John's was only able to beat out kids' pizza-and-games outlet Chuck E. Cheese, which came in sixth.

Key takeaway

Papa John's is in trouble. While it is purging Schnatter's image from all of its advertising -- the company founder was literally the face of the business -- it isn't doing anything to address the fundamental problems that existed before he became an issue.

And now it's had to extend financial assistance to its franchisees, agreeing to cut royalty payments and food costs to help them as customers flee.

Fixing the pizzeria's problems might require an extraordinary leader stepping in, like Doyle did with Domino's, but until that happens, it means Papa John's investors aren't finished getting burned. The very public spat between Schnatter and the board also means investors should stay away from this stock.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.