Pizza Pizza Royalty Corp. (TSX: PZA) collects royalty streams from two of Canada’s largest pizza chains: Pizza Pizza and Pizza 73. It collects 6% of the system sales from Pizza Pizza and 9% of the system sales from Pizza 73.
Pizza Pizza has over 800 stores in its royalty stream. The company has been operating with a persistently high dividend yield over 7.7%. Which begs the question is that yield safe or is this stock a yield trap?
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Pizza Pizza: Big dividend bet or dividend trap?
Despite being one of the largest pizza franchises in the country, all is not well in pizza land. Pizza Pizza cut its monthly dividend by 10% last quarter. Pizza Pizza saw same store sales decrease by 5% and total royalty pool sales decline by 3.6%. Adjusted earnings per share fell by 5.4%. That is despite adding 20 net new stores to its portfolio in the year.
Its dividend payout ratio had been trading well over 100% for several years. It had pursued an aggressive dividend-growth posture since mid-2020. However, that was not sustainable given that its payout ratio continued to inflate. In fact, the dividend had slowly eaten away its capital reserve to only $2.2 million.
The dividend payout ratio has been inflated for years
Even though Pizza Pizza is positioned as the value player in the market, it is getting hammered by a weakening economy, softening demand, and increased promotional activity in the industry. In essence, it is facing a fight to the lowest price.
That clearly showed up in third-quarter financial results. Same store sales decreased 2.3% and royalty pool sales decreased 0.8%. Adjusted earnings per share fell 1.7%. The company noted that it continued to face pressures from higher competition and lacklustre demand.
Fortunately, the dividend decrease in the prior quarter did have a positive impact on its financials. Its payout dropped to a more sustainable 93%, and Pizza Pizza actually bolstered its working capital reserve by $400,000 to $2.6 million.
The macro outlook doesn’t favour the dividend
While the dividend cut seems to be helping, there are other concerns to monitor. In the quarter, Pizza Pizza pulled back its restaurant development outlook from 2% to 3% growth to 1% to 2% growth this year. The company is having a hard time finding qualified franchisees. Likewise, construction timelines and rising costs are delaying new franchise commencements.
Certainly, the macro environment isn’t helping them either. The Bank of Canada just increased its base interest rate by 25 basis points. When the Bank of Canada tightens, it often does it in twos. So, we are likely to get another rate increase in December.
All that will further strain consumers who have both inflation and elevated debt service costs to deal with. Certainly, this plays a factor in whether someone decides to invest in a Pizza Pizza franchise. Franchisee costs are rising as are the input costs for the pizzas they are selling. It creates a perfect storm for Pizza Pizza.
Pizza Pizza is stuck between a rock and a hard place
While Pizza Pizza’s reduced dividend appears sustainable now, the future does not look particularly bright. While a 7.7% yield appears attractive, it has come at a 33% loss in the stock value. Its dividend doesn’t look particularly safe given its declining business fundamentals. As a result, Pizza Pizza is more likely a dividend trap than a dividend opportunity today.
