Marcial: Pros Turn Cold on California Pizza

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The restaurant chain's sales remain in a slump, in part because of heavy exposure to the company's hard-hit home state


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Almost everyone loves pizza, long an inexpensive mainstay for Americans. And with an economic downturn, you would expect pizza sales to be piping hot.


Surprisingly, that's not the case for one of the largest casual-dining restaurant chains specializing in pizza. Sales haven't been sizzling at California Pizza Kitchen (CPKI), which operates 256 parlors offering premium pies. The softness led the company to post less-than-impressive third-quarter results on Nov. 6.


That sent California Pizza's stock tumbling to 12.76 from 13.84 the day before. On Apr. 24, the stock was trading at a 52-week high of 17.44.


"We think the sell-off is due to reaction to the company's weak guidance on same-store sales of a 5.5% to 6.5% drop in the fourth quarter" even after a 7.2% decline in last year's fourth quarter, says analyst Mark Basham of Standard & Poor's (MHP), who rates the stock a sell. He puts his 52-week target price at 12, based on his earnings estimate of 80¢ a share for 2009 and 75¢ for 2010.


Sales Down, Profits Up


For the third quarter of 2009, California Pizza reported earnings of $5.8 million, a 16.8% jump from a year earlier, despite a 5.3% drop in sales, to $164 million, which included a 5.7% decrease in restaurant sales, to $161.2 million. The profit rise resulted mainly from cutbacks in labor and energy costs.


Same-store sales tumbled 8%, with July sales down 9%, August off 7.2%, and September down 7.3%, according to Susan M. Collyns, the company's chief operating and chief financial officer. California Pizza's stores are located mainly in California, Florida, Illinois, and Texas. Overseas, it has stores in Hong Kong, Mexico, Singapore, China, Japan, South Korea, Dubai, Guam, Indonesia, Malaysia, and the Philippines.


S&P's Basham says his sell recommendation reflects his negative outlook for the casual-dining segment of the restaurant industry, as well as the company's high exposure to the particularly hard-hit California market.


Paul Westra, an analyst at investment firm Cowen (COWN), rates California Pizza underperform based mainly on what it reported for the third quarter. He notes that management forecast below-consensus estimates for the fourth quarter of 16¢ to 18¢ a share. The analysts' consensus estimate was 20¢.


Westra figures that at its current price, the stock, based on his estimated 2009 earnings of 78¢ a share and 2010's 85¢, "more than fully reflects California Pizza's growth prospects."


Catering and Frozen Pies


The bulls on California Pizza point out that the company has high-margin revenue opportunities through its licensing and franchise businesses. California Pizza has a strategic alliance with Kraft (KFT) to make and distribute a line of company-branded frozen pizzas in the U.S. and Canada. But analyst Matthew diFisco of Oppenheimer says that despite the Kraft partnership, he expects revenue growth to continue to lag its peers. "Therefore we see limited [price-earnings] multiple expansion" for the stock, says diFrisco, who rates the stock "market perform" or neutral.


Could sales comparisons get worse? If they do, it could spell trouble for the company's earnings. "A continuation of sluggish [same-store sales] comparisons could prevent earnings-per-share growth," especially when the benefits from cost reductions diminish, says David E. Tarantino, analyst at investment firm Robert W. Baird. (It has done business with California Pizza.) He rates the stock neutral, based on a "positive long-term view, tempered by prospects for sluggish traffic trends" that could hamper the stock's advance.


It will be up to California Pizza to drive up traffic and sales. In that regard, the company initiated a catering service in November and will launch a new frozen pizza line, as part of its pact with Kraft, designed for Whole Foods (WFMI) stores. And it has a new low-priced wine list at its restaurants.


In the meantime, unless the company's sales growth can get back on track, it may be wise for investors to try the pizza—but avoid the stock.


Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.