“YOU DON’T BECOME THE WORLD’S LARGEST PIZZA COMPANY BY ACCIDENT.” – This may have been true a while back however Pizza Hut has recently suffered a few blows.
Pizza Hut’s largest U.S. franchisee, NPC International Inc., is the fifth largest restaurant unit operator in the United States based on unit count. NPC operates 1227 Pizza Hut restaurants in 27 states representing about 20% of the domestic Pizza Hut system. It is also The Wendy’s Co.’s largest franchisee, with 393 restaurants in eight states. The company ranked number 10 in the last year’s Top 150 Private Companies List with $1.55 billion in 2018 revenue however this year, it did not submit its 2019 revenue.
Yum! Brand (the owner of Pizza Hut) is almost fully franchised thereby shifting most risks related to labour, food costs and remodeling expenses to restaurant operators instead of the company directly. NPC’s largest unsecured creditor is Pizza Hut Inc. standing at $17.6 million.
NPC opened its first Pizza Hut location in 1962 in Pittsburg and went public in 1984. The franchise went private again in 2001 and was owned by a series of private equity firms before being sold in 2018 to two family offices, Delaware Holdings and Eldridge Investment Holdings.
How it took a turn for the worst?
In 2019, S&P Global Ratings and Moody Investors Services downgraded the credit ratings as NPC failed to make interest payments due to lenders on 31st January. The third quarter results which were released to the lenders in early November reported a debt to earnings ratio of 7.66 times for the period ended September 2019. This ratio put the company in breach of a covenant which required leverage to remain below 7 times.
In the beginning of 2020, NPC received a new $35 million loan to inject cash in the business therefore improving liquidity. Shares of Yum! A brand that has a market value of $31.3 billion were trading down 1% in February, 2020 whereas the stock of its rival Domino’s Pizza, having a market value of $15.1 billion, surged 24% after its fourth quarter earnings.
It was already known that NPC was facing some problems so, ahead of the pandemic, backed by private investment firm Eldridge Industries LLC, it brought in the help of restructuring advisors at law firm Wil Gotshal & Manges, investment bank Greenhill & Co. and operational advisor Alix Partners LLP. NPC defaulted on about $800 million of debt after it chose to skip loan payments. It entered into an agreement with the lenders to allow time to consider debt restructuring options.
Finally, on 1st July, 2020, NPC International Inc. filed for bankruptcy under Chapter 11 in the Texas Southern Bankruptcy Court. Seeking Chapter 11 protection means that NPC can continue to operate while it tries to turn the business around. Essentially, NPC owned Pizza Hut locations will continue to serve food for the time being. In its filing, NPC International Inc. listed estimated assets ranging from $1 billion to $10 billion and estimated liabilities in the same range.
Ahead of the bankruptcy filing, Cowen analyst Andrew Charles had estimated that Pizza Hut’s owner, Yum Brands, could lose up to $54.2 million of annualized royalty revenue and 13 cents of annualized earnings per share if NPC stops paying royalty fees so it does not paint a pretty picture for Yum! Brand.
The most interesting thing, inspite of the doom and gloom is that Pizza Hut was one of the few companies to report same store sales growth in April and May, thanks to higher digital and delivery services.
What caused the downfall?
NPC and Pizza Hut struggles with rising costs as it tried to expand delivery and move away from traditional dine in restaurants by opening locations that cater to pick-up customers. It also faces cut throat competition from rivals such as Domino’s Pizza Inc. and Papa John’s International Inc. Jon Weber, president and CEO of NPC’s Pizza Hut division said that they had been facing increased labour and commodities cost and a high level of financial leverage that presents obstacles to achieving the long term business objectives. These challenges have been magnified recently by the impact and uncertainty of Covid-19. New safety measures have been expensive, costing the company $750,000 per month.
Due to a drop in foot traffic and pricing pressure in the pizza category, Pizza Hut has lost market share to its competitors. The pandemic added with years of sloping U.S. sales for Pizza Hut has resulted in NPC struggling with a debt burden of roughly $1 billion. Despite Pizza Hut’s communication of its commitment to bring about a brand turnaround and to reinvigorate interest among people, the factors mentioned above has resulted in straining the financial performance of NPC and have limited its ability to operate profitability under its current balance sheet.
Reluctance by the Pizza Hut franchisor to invest in brand development, decreased menu innovation, and lack of a clear long term strategy has also resulted in a deteriorating brand image.
There’s still hope.
NPC has a pre-negotiated agreement with 90% of its first lien lenders and 17% of its second lien lenders. The plan is aimed at reducing the company’s debts with first lien lenders taking equity and potentially participating in a new cash injection. The bankruptcy filing can be seen as an opportunity to create a better future for NPC’s Pizza Hut restaurants. Focus can be given on restructuring and re-establishing an organization with a lower and more sustainable level of debt, ownership focused on operational excellence and a greater level of restaurant investment. NPC said that it would use the bankruptcy protection to engage in further discussions with its brand partners and other creditors to improve its financial position.
On the bright side, in a NPC press release, it was said that the bankruptcy filing will not result in the laying off of its 7,500 full time and 28,500 part time employees in the U.S.
NPC has until 24th July to work out a deal with Pizza Hut and certain creditors on restructuring the company’s pizza business otherwise it will have to sell an unspecified number of its Pizza Hut restaurants.
In light of the current pandemic, the food and beverage industry has been one of the worst hit industries especially during the lockdown phase. NPC joins a host of other companies that have filed for bankruptcy in the last two months including Chuck E. Cheese’s parent company – CEC Entertainment, rental car company Hertz and retailers J. Crew and J. C. Penny.
What everyone is waiting for is to see how many companies make it to the other side of the pandemic and survives. While we hope for the best, it’s obvious that it is going to take a long time for businesses to recuperate.