High cheese prices give Papa John’s indigestion

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Products like Papa John’s Epic Stuffed Crust Pizza have helped the chain’s sales, but margins remain an issue./Photo courtesy of Papa John’s.

Same-store sales for Papa John’s rose 0.9% in North America last quarter, giving the company its 12th straight increase and something its competitors didn’t have: a positive quarter.

Ah, but those cheese fees. Commodity costs for the Louisville, Ky.-based pizza chain rose 18% in the quarter ended June 26. That, combined with higher labor costs, represented an 800 basis point headwind to the company’s store margins, which fell 400 basis points. even after the company raised its prices.

“It really is a unique environment,” CEO Rob Lynch said in an interview Thursday. “We’re seeing 18% to 20% inflation in the second quarter, which is more than I’ve ever seen in my career.

“That doesn’t necessarily give you the opportunity to catch up.”

Cheese producer prices rose 21% year over year in June, federal data shows, amid a massive dose of inflation hitting restaurants and other businesses, which at in turn pass these higher costs on to consumers.

Papa John’s expects costs to remain high, particularly for dairy and wheat, before some relief towards the end of the year.

“I see light at the end of the tunnel,” Lynch said. “We’re going to come out of this hyper-inflationary period and see some normalization in our cost structure.”

But the margin issue helped drive down Papa John’s share price, which was down 4% in morning trading on Thursday. Net income for the quarter fell 21% to $25.4 million, or 74 cents per share, despite higher revenue.

Still, Lynch also noted that the company is struggling to balance consumer needs with margins. In other words, if you raise prices too much, you risk losing more customers. “We try to be good stewards of the P&L,” he said, referring to a profit and loss account. “But we’re trying to balance that strategically with maintaining the momentum of our business.”

And sales also showed some weakness at the end of the quarter. Lynch said the company experienced “a slight slowdown” in June, which he blamed on a higher level of travel from consumers who had previously stayed home, eating pizza.

“We’ve demonstrated this by looking at our travel markets,” Lynch said. “There are a lot of people going to Florida, where our business is growing strongly. So I think there’s a return to some of the seasonality that we’ve seen in the past.

Papa John’s sales struggled in 2018 and 2019 as it struggled to recover from multiple controversies that led to a management overhaul and the eventual hiring of Lynch as CEO. The company’s comeback began in 2019, and it’s had a strong sales streak ever since. The chain’s same-store sales are up 36% over three years.

It also outperformed its two main competitors. Rival Domino’s, for example, reported lower same-store sales in the United States in three of the past four quarters, including a 2.9% decline in the second quarter. Pizza Hut posted a 4% decline. These two brands in particular struggled with a driver shortage that reduced hours of service in many locations, which Papa John’s was able to avoid thanks in large part to its reliance on third-party delivery.

The company also generated higher sales by emphasizing premiumization. The company generated strong sales in the quarter with its Pepperoni Stuffed Crust pizza. Papa John’s also expects positive sales for the rest of the year.

“We’ve had 12 straight quarters of positive comps,” he said. “Most of our competitors are not positive. And we did more laps last year than anyone else.

“We feel we did a very good job of managing the margin while maintaining momentum,” he added.

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