My appetite for this high-yielding stock is waning fast

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Pizza Pizza promotes its food as “hot and fresh.” But lately, its publicly traded shares have gone staler than a day-old pie.

Since I launched my Yield Hog Dividend Growth Portfolio at the end of September, Pizza Pizza Royalty Corp. (PZA) has plunged about 19 per cent, making it the worst performer in the model portfolio.

Why is Pizza Pizza Royalty – which had served up solid returns for years – suddenly losing so much dough for investors?

First, rising bond yields have hurt dividend stocks in general, and high-yielding, slow-growing companies such as Pizza Pizza Royalty in particular. (Pizza Pizza Royalty doesn’t operate the restaurants but owns the chain’s trademarks, which it licenses to Pizza Pizza Ltd., the operating company, in exchange for a royalty on sales.)

Second, and more worrisome, sales have been falling, and there are no signs of a quick turnaround.

For the first quarter, same-store sales – which excludes the impact of restaurant openings and closings – slipped 0.2 per cent, as a 1.9-per-cent decline at the company’s Pizza 73 restaurants, located primarily in Alberta, more than wiped out a 0.1-per-cent gain at the larger Pizza Pizza chain, which is concentrated in Ontario and Quebec.

It was the third consecutive quarterly drop for same-store sales over all, and the 10th in a row for Pizza 73, which has struggled amid the downturn in Alberta. Same-store sales are the main driver of distribution growth for restaurant royalty stocks, so it’s no surprise that Pizza Pizza Royalty hasn’t raised its dividend in nearly two years.

But there’s more to the story than economic weakness in Alberta.

The fast-food business has always been competitive, but pizza restaurants – whose product is easy to make and transport – have enjoyed an edge thanks to their focus on delivery. The Pizza Pizza brand derives 60 per cent to 65 per cent of sales from delivery, according to the company, reflecting the success of its centralized call centre and catchy telephone-number jingle.

But pizza is no longer the only delivery game in town. Third-party delivery apps – such as Uber Eats, SkipTheDishes, DoorDash and foodora – are making it easy for consumers to order virtually any type of meal - burritos, burgers, sushi, you name it – on their smartphones.

Third-party delivery is “going to have an impact to the market, some places more than others,” Paul Goddard, Pizza Pizza Ltd.’s president and chief executive officer, said during the first-quarter conference call on May 9. The proliferation of delivery services “means that really any restaurant out there is also a competitor of ours, where perhaps it didn’t use to be.”

The expansion of U.S.-based pizza giants such as Domino’s and Papa John’s in Canada is adding to the competitive pressure, analyst Derek Lessard of TD Securities said.

“While the lack of a robust economic rebound in Alberta can mostly explain the weakness at the Pizza 73 banner, emerging trends affecting the larger Pizza Pizza brand continue to be a source of concern for us,” Mr. Lessard said in a note.

Historically, Pizza Pizza’s same-store sales grew by about 3 per cent annually, Mr. Lessard said, but he believes that level has been “permanently hit” by growing competition, high personal debt levels and an intensely promotional fast-food market.

Pizza Pizza Ltd.’s investments in mobile ordering and restaurant renovations should help, Mr. Lessard said, but he forecasts that same-store sales will grow by just 0 per cent to 2 per cent annually through 2020. Pizza Pizza Royalty could still increase its dividend by 1 per cent to 2 per cent over the next couple of years, he said, but “any further increase in competition and/or deterioration in the Canadian economy could cause the historically conservative board to move a bit more cautiously.”

Given the steep decline in Pizza Pizza Royalty’s shares, it’s clear that plenty of bad news is already baked into the stock price. The upside of the decline is that the shares, which closed on Tuesday at $13.36, now yield a hefty 6.4 per cent. That’s attractive – as long as the shares don’t continue to fall, of course.

I’m willing to give the company some time to get its sales moving in the right direction, but I’ll be monitoring the results closely. As much as I enjoy a juicy payout, I prefer my dividends with a side of growth.

Disclosure: The author owns shares of PZA personally and in his model Yield Hog Dividend Growth Portfolio. View it here.