Pizza giants fight to retain customers as economies reopen and diners venture outside

Published Tue, Apr 20 202112:26 PM EDT

Key Points

Domino's Pizza, Papa John's and Pizza Hut are under pressure to hold onto their new customers as economies reopen.
Out of the three stocks, Papa John's is the most expensive after the pandemic helped it shed the scandal created by its founder.
Pizza Hut is also in the middle of a turnaround. Its U.S. franchisee base is exiting the pandemic healthier after its largest U.S. operator filed for bankruptcy and sold off its units.

Pizza chains have a new common enemy: fatigue. Domino's Pizza , Papa John's and Yum Brands' Pizza Hut are under pressure from investors to live up to last year's blockbuster sales. Although expectations are high, the coronavirus pandemic has put all three chains in positions of strength as they try to hold onto their gains. Domino's, Pizza Hut and Papa John's all made modest market share gains in 2020, according to Euromonitor International. But competition will intensify this year as demand for pizza moderates. Domino's, which has long dominated the pizza landscape, faces competitors who received a leg-up on their turnaround efforts last year. Papa John's is finally shedding the scandal created by its founder John Schnatter in 2018, while Pizza Hut is shifting its reputation from dine-in pizzeria to a go-to restaurant for delivery and takeout . While all three pizza chains will face tough comparisons to last year's surging demand, Pizza Hut and Papa John's have the benefit of sluggish sales before the pandemic, giving them more room to run. "Whereas Domino's had essentially more than a decade of consistent growth in same-store sales, Papa John's has been more inconsistent and hasn't had the menu innovation that Domino's has had, so I think that there's just more low-hanging fruit for Papa John's to hold onto those [average unit volumes] and some of the sales growth that they had last year," BTIG analyst Peter Saleh said. Out of the three stocks, Papa John's is the most expensive, based on the company's forward price-earnings ratio of 40.7. Domino's falls to a distant second place, with a price-earnings ratio of 29.6 times, while Yum's 28.3 times ratio makes it the cheapest pizza stock. However, Yum's stock has been on a steady upward climb, hitting a 52-week high of $118.97 per share on April 15, while Domino's and Papa John's are weathering more volatility. Besides Pizza Hut, Yum also owns Taco Bell and KFC, which have both rebounded quickly from pandemic lows. RBC Capital Markets recently raised its price targets for two of the companies. The bank boosted its price target on Domino's to $446 from $428. Yum's price target was hiked to $112 from $111. As of midday Tuesday, Domino's was trading at about $398 a share, while Yum's stock hovered around $117. "A lot of these [pandemic play] stocks have underperformed lately on this idea that when the economy reopens, it's back to business as usual," said Jeff Bilsky, a portfolio manager for Chartwell Investment Partners. "But I think that might be true only in the short term." Healthier franchisees In addition to adding more cash in the companies' pockets, the pandemic pizza trend also helped their operators. "All their franchisees got a little bit healthier," Saleh said. Domino's franchisees saw the profitability of their stores rise , while Papa John's annual unit volumes in the United States hit $1 million. But Pizza Hut was the chain that saw the largest difference in its franchisee base. Its largest U.S. franchisee, NPC International, filed for Chapter 11 bankruptcy last July . Pizza Hut struck a deal with the ailing operator to close up to 300 of NPC's locations, including many outdated dine-in restaurants. Flynn Restaurant Group, already the nation's largest franchisee, bought 937 Pizza Huts and 194 Wendy's restaurants from NPC. Greg Flynn, CEO of Flynn Restaurant Group, said that he made the deal because he believes in the Pizza Hut brand and thinks that the chain's turnaround plan will be successful. The restaurant group's Pizza Hut portfolio includes about 200 dine-in locations, which he said will probably require some conversions into smaller, delivery-focused units. "The portfolio is now bearing much less than half of the debt than it was carrying before, which brings in a lot of dollars to reinvest in the restaurants and to run them with the right labor model," Flynn said. Flynn Restaurant Group's size also means that it has easier access to capital than a smaller operator would. With roughly $3.5 billion in annual sales, it's the third-largest overall restaurant operator in the United States, falling behind Starbucks and Chipotle Mexican Grill . Pizza Hut also is under new management. More than a year ago, Yum tapped Kevin Hochman as interim U.S. president amid another executive shuffle at the pizza chain. He led the turnaround of KFC in its home market and still holds the role of U.S. president for the fried chicken chain. Still, BTIG's Saleh isn't sold on Pizza Hut's turnaround just yet. "They've been in turnaround mode for as long as I can remember, so I'm not willing to say yet that this will be the catalyst that gets them to put their comps in positive territory indefinitely," he said. Fighting pizza fatigue As all three chains try to retain customers, they're fighting pizza fatigue with new menu items. "We'll be the first to admit that we took longer than we should to introduce new things to our menu," Domino's chief financial officer Stu Levy told investors at a UBS conference in February. "We went with a several year gap that we would not anticipate going forward." In recent years, Domino's innovation efforts have been more focused on its technology, investing to make ordering and receiving a pizza faster and easier. But last summer, Domino's unveiled two new specialty pizzas — chicken taco and cheeseburger — and new chicken wings, which have also enjoyed a surge in popularity during the pandemic. Levy said that the company has been selling all of the chicken wings it could get its hands on, and it hasn't even advertised the menu item on television yet. The downside is that chicken wing prices have surged amid the demand. There even was a shortage ahead of the Super Bowl . Papa John's has recently added Epic Stuffed Crust , which the chain is planning on making a big part of its 2021. BTIG's Saleh said the stuffed crust has helped sustain double-digit same-store sales growth for the pizza chain through the first week of March, even in states that have reopened. Shortly before U.S. lockdowns last year, the chain launched Papadias, flatbread pizza sandwiches that have been bringing in incremental sales for Papa John's. Pizza Hut tends to lean on limited-time options to jazz up its menu, launching Detroit-style pizza in January . The brand's management now has greater marketing control to tout its promotions, thanks to an agreement it recently struck with franchisees in exchange for investments in new restaurant equipment and remodeling. Yum's two recent tech acquisitions will also aid Pizza Hut in reaching new customers online. Low prices will likely help the three chains remain attractive to cash-strapped customers. While many consumers are preparing for a summer of revenge spending after months of no travel and little dining out, many will still lack jobs and financial security. From a value perspective, Domino's $5.99 promotion presents the best deal for consumers, according to Saleh. But it has new competition from Pizza Hut, which launched its $10 Tastemaker deal in September, offering a large pizza with any three toppings for a family meal. It's a familiar strategy from Hochman, who introduced the $20 Family Fill Up bucket at KFC to turn around sales in 2015. "As life returns to normal and customers have more food and dining options, we feel confident the plan we have in place for Pizza Hut will continue to provide customers with the pizza they love in a relevant, easy and distinctive way," Hochman said in a statement to CNBC. Outside competition Pizzerias weren't the only ones delivering food during the pandemic. Third-party delivery companies like DoorDash and Grubhub reported strong quarterly growth as more consumers used their apps for the first time. Third-party meal deliveries rose 137% in February 2021, according to analytics firm Second Measure. Forty-seven percent of U.S. consumers have used a third-party delivery app, up from 37% a year ago. Out of the three largest publicly traded pizza chains, only Domino's has stayed away from partnering with any third-party apps. For Papa John's and Pizza Hut, the apps offer them the opportunity to reach new customers, but they also charge hefty commission fees on every order that either eat into the profitability of the transaction or are passed onto customers. Domino's charges its franchisees about 27 cents for every online transaction, according to its franchise disclosure document. Industry experts are predicting that third-party delivery will be one of the trends that sticks around long-term. NPD Group analyst David Portalatin said that eating restaurant food at home was a trend that already existed. The pandemic only accelerated the behavior. For pizza chains, that could be bad news because the apps offer consumers a wider array of meal options. Nevertheless, Papa John's said that its aggregator sales are still strong even as the world returns to normal. One factor is definitely in favor of Domino's, Pizza Hut and Papa John's: They're still in business. One in 10 U.S. restaurants have closed permanently, according to a March report from Datassential, a firm that tracks restaurant menu penetration. Chain restaurants look more likely to snap up that market share, since they've rebounded faster than independent eateries. "That's a pretty big number. This isn't the tech sector, this is restaurants," Chartwell's Bilsky said. "Just 10% market share across the board is a lot."

An employee moves pizza boxes before a delivery at a Domino's Pizza restaurant in Chantilly, Virginia.

Andrew Harrer | Bloomberg | Getty Images

Pizza chains have a new common enemy: fatigue.

Domino's Pizza, Papa John's and Yum Brands' Pizza Hut are under pressure from investors to live up to last year's blockbuster sales. Although expectations are high, the coronavirus pandemic has put all three chains in positions of strength as they try to hold onto their gains.

Domino's, Pizza Hut and Papa John's all made modest market share gains in 2020, according to Euromonitor International.

But competition will intensify this year as demand for pizza moderates.