The Exchange

Papa John's run-up draws a crowd — of short sellers

The Exchange
Papa John's employees David Noel, left, Jimmy Sosa, middle and Dan Krug prepare pizzas inside the New Hyde Park restaurant, the 4000th Papa John's store on Friday Sept. 14, 2012, in New Hyde Park, N.Y. A grand opening celebration took place. (Photo by Kathy Kmonicek/Invision for Papa John's/AP Images)
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Papa John's employees David Noel, left, Jimmy Sosa, middle and Dan Krug prepare pizzas inside the New Hyde Park restaurant, the 4000th Papa John's store on Friday Sept. 14, 2012, in New Hyde Park, N.Y. A grand opening celebration took place. (Photo by Kathy Kmonicek/Invision for Papa John's/AP Images)

Short sellers have been building an ever-larger position in pizza chain Papa John's (PZZA) over the past several months, an accumulation that measures as the third-biggest percentage increase among 42 publicly traded restaurant stocks examined.

According to data available on Nasdaq.com, the number of shares in Papa John's sold short totaled 1.64 million as of Feb. 14, up 173.7% since the middle of last March. The spike is particularly apparent back to this past October, when short interest surged from 453,903 shares to 857,568 shares in a two-week span. It's trended upward ever since for the No. 3 U.S. pizza chain by unit count, with only barbecue seller Famous Dave's (DAVE) and sandwich shop Potbelly (PBPB), public less than half a year, showing a more pronounced change of all the restaurants surveyed.

It's still not an overwhelming position overall in the stock, and short interest does fluctuate, sometimes quickly and considerably so. For instance, Canadian doughnut shop Tim Hortons (THI) went from 1.8 million shares sold short to fewer than 500,000, then back above 2.3 million and now down to 246,000, all since last March. Plus, 21 of the other restaurants in the group have had an upsurge in short interest from last year, whereas 20 have seen a decrease. What's worth noting for Papa John's is that the recent escalation comes at a time when shares are arguably stretched in what's a broadly expensive set of stocks.

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As to why the shorts might find this name appealing, it's not because Louisville, Ky.-based Papa John's, known for its ads with founder John Schnatter and Broncos' quarterback Peyton Manning, is falling apart. Revenue and earnings, in fact, have climbed annually for a few years in a row and are likely to do so again this year, although the compounded top line yearly rate is slightly under 5%. That said, sales in the most recent fourth quarter were stronger than expected, while profits met expectations. The company is planning to open about 200 restaurants a year, mostly overseas, in the next six years, to join the 4,400 it has in its system. It's also recently started paying a small dividend.

However, with a forward price-to-earnings ratio of 30.1, Papa John's is 13.5 points above its five-year average of 16.6. In our survey group, only Steak 'n Shake owner Biglari Holdings (BH) and BJ's Restaurants (BJRI) have a larger deviation from their average, FactSet data show. There are multiple reasons a trader might choose to short a stock, but in this case, it may be the view that it's overheated.

Even as traffic has been uneven and revenue lukewarm, most of the restaurant stocks have soared and now are trading ahead of their next-12-months P/E. Still, 5.2 points is the norm, meaning Papa John's has a gap of about three times the group average. As an industry, these stocks carry a 27.2 multiple, vs. around 22 that's been seen generally in the past half-decade. It also has one of the higher price/earnings-to-growth ratios at a 2.2, making it one of seven at 2 or above. Certain other valuation measures, including price-to-sales, are at or near five-year highs.

For losers?

Betting against Papa John's, or restaurants in general, has been a losing proposition. If it keeps outpacing the market and its brethren, that will remain the case. Regardless, as long as its valuation stays where it is or continues going, the odds probably get better that an increasing amount of doubters will at least take a look at it.

Papa John's has been one of strongest stocks this year in the group, trailing only Burger King (BKW) and Jack in the Box (JACK) as of mid-afternoon Tuesday, with a 17.3% gain to $53.15. That comes after a year in which it rose 65.3%, the best showing in its five-year winning streak and ahead of the group average of 54%. (The S&P 500 recorded a 29.6% advance in 2013.) As has been the case for many stocks amid the broad market rally, Papa John's has hit multiple all-time highs along the way, most recently Monday of this week. That ceaseless climb has lifted it above Wall Street's consensus price target of $51.17.

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At the moment, the burgeoning short isn't an indictment of Papa John's, though the developments here do bear watching, both for their ability to put pressure on the stock and to produce added lift later owing to a possible short squeeze. On StockTwits, an online trading-ideas forum, only a handful of posters commenting on Papa John's are downbeat. One recent technical analysis piece, found here, delved into why a continuation to $60 could happen.

The next short interest report is due in only a few days. If it follows the trend, more traders will be expecting the shares to come down from their impressive heights. And there's probably room for them, as sentiment isn't remotely negative in a significant way. Currently, short interest comes to about 6.2% of the float, according to Yahoo Finance data, below the 7.5% average for the industry.

But if detractors remain intrigued, we could be at the beginning of a bigger short position to come. Or it could be just another quick route to getting burned in a dangerous market for skeptics.

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