After 26% Rally in Papa John's, Short Sellers Target Pizza Stock

Papa John’s International Inc.’s shares have rallied 26 percent in 2015 on the pizza chain’s surging profit growth and technological advancements, making it one of the richest restaurant stocks around. An increasing number of short sellers don’t think that will last.

The number of shares being shorted -- a bet that the stock will fall -- has risen to 5 percent of those outstanding, near the highest level in six years, according to data compiled by Bloomberg and Markit Ltd. The investors are wagering that Papa John’s will have a tough time sustaining its lofty price-to-earnings ratio of 36.4. That valuation puts it behind only Starbucks Corp. and Chipotle Mexican Grill Inc. among big North American restaurant chains.

Short sellers are increasingly targeting Papa John's International.
Short sellers are increasingly targeting Papa John's International.

The broader question is whether Papa John’s can keep up the pace of sales and profit growth in an increasingly crowded pizza market. The Louisville, Kentucky-based chain has attracted customers in recent years by touting natural ingredients and online-ordering features. But competition is getting stiffer. Papa John’s large pizza rivals are improving their technology, and upstarts such as Blaze, Mod and Pieology are expanding quickly, aiming to take Chipotle’s fast-casual approach to food and apply it to pizza.

“Eventually they may cause a problem for the big chains,” said Peter Saleh, an analyst at BTIG LLC.

Stock Rally

Papa John’s fell 4.3 percent on Friday, a sign investors are getting more bearish on the stock. Still, it has trounced the 1 percent gain for the Standard & Poor’s 500 Index this year. And the run-up in 2015 follows six previous years of stock increases for the restaurant chain. The shares rose 1.9 percent to $71.47 as of 12:23 p.m. in New York on Monday.

Papa John’s is the fourth-largest pizza company in the U.S., with systemwide sales of about $2.67 billion in 2014, according to the research firm Technomic. The company ranks behind Yum! Brands Inc.’s Pizza Hut, Domino’s Pizza Inc. and Little Caesars Enterprises Inc. in the industry.

The race to build more sophisticated ordering technology has made pizza chains more efficient. By letting customers pick out their pizza on an app or website, companies can reduce errors and potentially use less labor. Last December, Papa John’s said it was the first of its competitors to generate 50 percent of its sales through digital channels.

That technology could be a bludgeon that helps Papa John’s keeps small pizza chains at bay, Saleh said. Many restaurants can’t afford those capabilities, he said.

"The digital technologies are very expensive to implement," said Saleh, who has a buy rating on Papa John’s. "It makes it very hard for the independents to compete for the younger customers."

Industry’s Gains

Still, food-service companies in general are attracting more short sellers as their PE multiples climb, said Mark Kalinowski, an analyst at Nomura Securities. The S&P 500’s restaurant index has risen 23 percent this year, outperforming a choppy market. Starbucks has a PE ratio of 37.9, almost three times the level of Apple Inc., while Chipotle’s stands at 37.7.

Shake Shack Inc., the burger chain that went public in January, saw short interest soar after its stock price more than doubled. In that case, investors are betting that its valuation has gotten way ahead of its expansion plans: The chain boasts a $1.65 billion market value despite only having 74 locations as of September. Noodles & Co., which has a PE ratio of 39.1, also is heavily shorted.

Larger chains have come under scrutiny too, including Yum and McDonald’s Corp.

"The entire restaurant space has been under a lot of pressure, especially the high-multiple names," Saleh said.

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