Papa John’s Int’l, Inc. (PZZA), Yum! Brands, Inc. (YUM): 3 Evaluating Ratios: The Pizza Industry

I’m not just talking about your taste buds when I suggest that the Pizza industry could have you salivating. There is lots of investment potential in the three pizza giants: Papa John’s Int’l, Inc. (NASDAQ:PZZA), Domino’s Pizza, Inc. (NYSE:DPZ) and Yum! Brands, Inc.(NYSE:YUM)-owned Pizza Hut. In this article, I will compare the three based on three of my favorite metrics that I will hopefully be introducing you to today. Although they are not significant enough to make a buy or sell decision, they will hopefully help you further evaluate companies beyond the criteria you may normally use, both in the pizza industry, as well as in many others. For the sake of comparing companies in the industry, I included Pizza Hut, one of the largest members, which is owned by Yum! Brands. However, Yum also owns many other companies, like Taco Bell and KFC. So, the numbers for Yum! Brands, Inc.(NYSE:YUM) may be a bit skewed or unrepresentative  however, I am including them to help compare between the brands. That being said, let’s get started.

Asset Utilization

Measuring a company’s asset utilization is one of my favorite metrics to use, and it is great way to measure the efficiency of a company. In determining which of these three companies may belong in your portfolio, there are obviously countless factors, and efficiency is one of many things to take into account. However, for the sake of analyzing the companies broadly, asset utilization is one of the ways I will be using.

Asset utilization, for those who do not know, calculates a company’s total revenue earned for each dollar of assets that the company owns. For example, a ratio of 70% means that the company earned $.70 for every dollar of assets that it holds. A higher percentage tends to indicate a higher efficiency with this ratio.

While it is not always pinpoint-accurate, the ratio does usually give us a good indication of how each company is in terms of efficiency. So, given that, let’s take a look at the graph:

As you can see, all three are incredibly efficient, boasting well over 100% efficiency, with Pizza Hut and Domino’s in the 300% range. However, typically the ratio is more effective when using it to compare companies side-by-side. Furthermore, it helps to use the ratio over a history of a few years, as opposed to just a current value. An increasing asset ratio over time indicates a company being more efficient with every dollar of assets. However, the three companies have kept near-constant asset utilization levels over the past few years. Papa John’s Int’l, Inc. (NASDAQ:PZZA) seems to show the highest increase in efficiency over the past few years, making them a solid long-term bet. Domino’s Pizza, Inc. (NYSE:DPZ) was steadily increasing as well until abrupt fluctuations began a year ago, making it impossible to fully understand which way they are going in this regard. And, finally, Yum! Brands, Inc.(NYSE:YUM), while its ratio is lower now than it was a few years ago, the drop is so small that it is essentially negligible, and they have very good asset utilization to justify a slight drop over a few years. Still, in the end, Papa John’s comes out on top for this metric by a hair.

KZ Index

The KZ index measures how a company might fare should conditions “tighten” financially. More specifically, the KZ index, or Kaplan-Zingales index, measures, relatively, a company’s reliance on external financing to determine which companies may be more likely than others to experience difficulty financing ongoing operations should conditions worsen. In an industry in which production costs are ever-changing, and an economy in the state that is currently is in, this is a very important metric.

The calculation of the ratio is incredibly long and complicated, so I left it to the computers to do it for me, but if you are interested in knowing the specifics behind calculating it, you can look here.

Let’s look at the chart:

For this ratio, a lower score represents a lesser probability of financial difficulty during tightened economic conditions.

It’s important to remember that all scores with this metric are relative. So, looking at the results of for the three companies, Papa John’s Int’l, Inc. (NASDAQ:PZZA) rings in at 2.236, with Yum at -.568 and Domino’s at an astounding -61.06. I know these numbers mean nothing yet, so let’s analyze what they mean.

A lower score is considered more ideal with this metric. A score of -14.43 puts companies in the 90^th percentile, meaning that only 10% of companies have better scores than that; whereas a score of 10.12 means that 90% of companies have a better score, with a pretty crazy curve in between.

Papa John’s score places them in the 45^th percentile, meaning 55% of companies have better scores than they do. Yum! Brands, Inc.(NYSE:YUM) is in the 56^th percentile, while Domino’s is in the 99.9^th percentile, with one of the highest KZ of all companies in America.

This means that, according to the index, Domino’s would have nearly no trouble financially in a crisis situation, while Yum would most likely have no trouble and Papa John’s Int’l, Inc. (NASDAQ:PZZA) may be susceptible to trouble. So, Domino’s crushes the competition here.

Finally, let’s look at the third ratio I’ve chosen.

Tangible book value per share

Tangible book value per share, or TBVPS, is a measurement of the portion of tangible assets (all assets, with the exception of goodwill and items classified as “intangible” on a company’s balance sheet) attributable to each share of the company’s common stock. What this means is that it is helpful in establishing the valuation of a company, and whether or not it may be over or undervalued. This is important because lots of company’s balance sheets can reflect asset valuations that are inflated by intangibles; yet, if a company were to go bankrupt, the tangible value of assets a company has would be what is left over after bankruptcy. A simple way to put this would be that tangible book value answers the question, “as a shareholder, what would I receive if the company had to liquidate all of its assets?” By measuring this value per share, we create a ratio that measures valuation.

A TBVPS larger than the current price of the stock means that the stock could be potentially overvalued, whereas, obviously, a TBVPS smaller than the stock could mean that the stock is potentially undervalued. Formulaically, for those who are interested, TBVPS is equal to: (Tangible Book Value – Book Value of Preferred Stock) / Common Shares Outstanding. Now, let’s look at each company’s TBVPS in relation to their stock price.

As you can tell, both are potentially overvalued. So, which could be the most overvalued? To do this, we can simply divide the TBVPS by the current stock price, where the lowest TBVPS / Price would represent the company potentially the most overvalued.

So, according to this metric, all three are potentially overvalued, with Domino’s ringing in a negative TBVPS / Price ratio. All three companies are potentially incredibly overvalued, meaning that investors should invest with caution. However, Papa John’s Int’l, Inc. (NASDAQ:PZZA) comes in at the closest to having a TBVPS equal to the current stock price, meaning they limp out of this round with the win.

Foolish bottom line

Obviously, there is much more at stake than these three metrics, and no company should be added to a portfolio based on solely these three things. However, these should help as a guideline when deciding between companies in an industry. My hope here was to help introduce you to a few not-so-common ways to evaluate a company that are still very useful.

So, in the end, who won? Well, Papa John’s won 2/3 of our “contests,” putting them in the lead, with Domino’s winning just 1. That certainly isn’t a knock against Domino’s. In fact, their KZ index was off the charts. However, no company should be fully evaluated based on something that is not exactly pinpoint accurate. Plus, their TBVPS / Price ratio was a bit concerning…

Still, these three metrics are not enough criteria alone to make a buy or sell decision. However, they should help educate you about three little-known metrics that can be very helpful in evaluating a company, and hopefully are something you are now familiar with enough to use with other industries

The article 3 Evaluating Ratios: The Pizza Industry originally appeared on Fool.com and is written by Michael Nolan.

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