Trading diary entry: Purchase of Kotipizza

This post continues my unpolished “Trading diary entry” series, this time about Kotipizza, which I bought about two years ago and erroneously sold by end of 2016 “because high P/E”, and now bought back of continued good performance.

My original and more detailed writeup from 1,5 year ago can be found here

6.10.2017: Bought Kotipizza shares @ average ~14,2 eur/share

I made the purchase because the growth this year has been 18% and in september the growth accelerated to 25 %, yet the forward P/E per my own extrapolation based estimate is only 16.

This is too low relative to theoretical value because of low beta, no reinvestment needs and growing very fast, justifying 20+ P/E multiple.

The position is now 5%. The trade execution was 2,5% at the time two times a row, so it was barely within the 2,5% per trade rule.

But the first trade was made as I was looking at the stock at work after the (excellent) september system sales release, and the boss came to the office, so I panicked and pushed the purchase button.

So the trade was made emotionally which is bad (but to my defense I have been following the stock for years and more deeply yesterday and this week, so the actual decision had probably been made by some side of my brain earlier and the situation just being the trigger for action).

The second trade, few hours after the first trade, after the work day, I played around with Kotipizza’s numbers more, which basically confirmed my earlier earnings estimate for 2017E and thus implied 16x forward P/E.

I compounded my earlier trade execution error, as the decision was also made emotionally, but this time probably from “fear of missing out” because “the forward multiple is so low, because the online channel is getting traction and because the store network is expanding again and because I’m fan of the concept”.

So, I like the brand and it’s potential but dislike the management, because excess salesmanship, focus on EBITDA and strategy to purchase new concepts, not focus on Kotipizza which is unique.

The multiple is quite low and DCF models with 8% wacc and high growth in first years and then slowing growth after that, points to well over 20 eur valuation i.e. significant upside.

The question, rather than the exact revenue forecasts, is the growth trajectory and durability of earnings/market position.

The growth trajectory is partly function of appeal of the physical store concept and related marketing.

These are working excellently currently and there is plenty of room for new stores (say 50, implying 20 meur more system sales with 0,4 meur average store sales, which is probably too low estimate of current average store performance).

Restaurant concepts come and go, generally, but there are some that seems to last for decades, the likes of MCD, Taco Bell, Dominos, Pizza hut, Burger King, AND KOTIPIZZA.

Kotipizza has brand equity from the eighties and it’s the ONLY big nationally known fast food chain focused on PIZZA in Finland.

And few years ago, when Kotipizza was failing, the failing meant slower relative performance to market, not some sudden death or loss of competitiveness scenario, re the well published retail deaths recently.

People are sticky for good food and promise of consistency, that the 30+ year Kotipizza brand gives, IMO.

The store concepts are cheap to build (70 keur) so they work profitably in smaller towns, where they have big advantage because the markets are too small for big international brands and because they are the only BRANDED fast food chains option on smaller places.

This has all kinds of advantages and some people want that experience and status signaling, not kebab.

And for out-of-town people, who don’t know to what local kebab you can actually go, the branded fast food chain might be the only option.

In big cities, most of the stores are in populated living areas, not in prime retail/city center locations serving mostly the eating home market, either by store pick up or home delivery.

They are smaller local micro markets where there is no big fast food chains to compete but local kebabs and equivalents.

Now that, with the new concept and marketing and brand focus on signaling quality and sustainability, the customer might perceive that Kotipizza’s higher prices are actually justifiable, as against the old concept, marketing and brand, where the prices were higher but the (signaled) quality image low.

Actually, I think the main explanation for the sudden change in Kotipizza’s performance is the new congruence between premium prices and high quality image, as opposed to old incongruence of premium prices but perceived low quality.

As now Kotipizza’s concept, marketing and brand image is evidently working, each of the micro local Kotipizza franchises relative advantage has improved especially as the franchisees’ marketing association pounds Kotipizza’s message in national television at prime time.

Local kebabs do not and will not have this weapon.

The big growth case is the online channel, which has changed the international pizza markets where the big international brands have been winners and local kebabs the losers, per my perception based anecdotal evidence from reading stuff online and UK Dominos annual reports – main reason being lack of marketing and home delivery capabilities, and also to some extent proprietary online application where they control the channel (Kotipizza has hybrid approach, it has own app and 3rd part app called Wolt).

Kotipizza is growing 30%+ online and more and more franchisees are offering the home delivery option.

The big question regarding the valuation is how long can the growth continue and it’s difficult to give definitive answer to that.

There are a lot of local kebabs from who Kotipizza can take market share.

General retail is in trouble which will open better and cheaper locations in the prime retail areas.

When competing from the leases, Kotipizza as national brand as a lessor is an attractive partner.

In the prime retail areas the average store sales could be significantly higher than they are in the outskirts, where most stores are currently located.

In the prime retail positions the stores would be within delivery distance of lot of office workers, which could, with the online channel, boost sales significantly.

The online sales are currently 10% of sales while international at fast food chains the share is 50%.

Kotipizza will have the same IMO, just don’t know when.

The nice thing about the shift of sales to pizza apps is that people order more often and with bigger average tickets than in eating in store/via phone, at least it’s the Dominos UK experience – it’s just so low friction and so much easier to make the orders than alternatives (Kotipizza has panic button in their app, so when you have cravings the warm pizza arrives at your home with one push of a big red button within half an hour).

So, because of the growth trajectory and the low valuation, the I bought the shares

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3 thoughts on “Trading diary entry: Purchase of Kotipizza

  1. Thanks, interesting post.

    That online order share looks mighty low. Any ideas why it’s so low? I would have thought Finland would be an early adopter here.

    Have you ever looked at DP Poland? Much earlier in its development, not yet profitable. and probably not cheap enough. But maybe interesting to keep an eye on as it develops. (BTW, their online order rate as of last year was nearing 70%)

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    • Hi thanks for the comment. Kotipizza’s online channel is in early stage because the online and mobile stores were essentially opened last year or so, where the essentially opening means that the online shop and first versions of the mobile apps appeared to internet, not any big marketing or so.

      My theory is that the online channel marketing has not started in big scale because there were not many franchisees offering home delivery option (they can choose).

      They were not offering it because it’s quite expensive to hire extra employee for full time delivery and historically there was not enough extra revenue to justify the cost.

      But now the number of franchisees offering the home delivery option has started to increase, probably because they see the growth in the online sales in the places that offers it.

      As said, Kotipizza is the only national scale branded PIZZA fast food chain in Finland, so it doesn’t have to compete against other branded national or international pizza chains online (or elsewhere)

      There is online app platform for kebabs (pizzaonline), but my perception is that it’s quite low quality offering.

      If Kotipizza gets enough restaurants to offer the delivery option, it can start advertising nationally, which I think would increase the online channel popularity significantly because my perception is that the pizza app thing has not gained wide acceptance/knowledge/trust to the service providers among Finnish citizens yet.

      In that case kebabs, popular in Finland, could start losing market share because they cannot respond with credible marketing/trustworthy home delivery/propriatery online channel.

      EDIT 11.10.2017: Fixed biggest writing errors

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    • And I haven’t looked at DP Poland, I think I have seen some short commentary on it earlier though. Interesting case.

      But I think that the Kotipizza’s future is 50%+ online share, based largely on what has happened internationally already, the DP Poland’s case being supportive of my theory (in my mind).

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