Stocks like Domino’s Pizza (NYSE:DPZ) don’t go on sale very often. But to some investors, “on sale” might be an exaggeration.
Domino’s Pizza stock, even after its recent selloff, is hardly cheap. Indeed, DPZ stock still trades at over 22 tines analysts’ consensus earnings per share estimate.
That’s a huge multiple for a relatively mature company. And given that DPZ stock has tanked lately in part due to its big Q4 earnings miss last month, it’s a multiple that might not seem all that attractive.
But DPZ has plenty of room to grow into that multiple. Between the company’s same-store-sales growth and the new stores it will open, its revenue should continue to increase nicely for years to come. Given its franchise model and the leverage on its balance sheet, its higher revenues will have an amplified effect on its earnings.
DPZ is still facing risks. But those risks seem manageable, as Domino’s is well-positioned to handle any challenges ahead. DPZ stock isn’t cheap, but stocks like this shouldn’t be, and they very rarely are.
The Case for DPZ Stock
DPZ simply has come to dominate the pizza business. Yum! Brands’ (NYSE:YUM) Pizza Hut’s growth has stalled out in recent years. Papa John’s (NASDAQ:PZZA) sales are collapsing. Yet Domino’s keeps growing at impressive rates.
Indeed, during the company’s “disappointing” Q4, its U.S. same-store sales rose 5.6% year-over-year. Meanwhile, Pizza Hut’s comparable-store sales were unchanged. Papa John’s comps fell 8%. McDonald’s (NYSE:MCD) same-store sales rose 2.3% in Q4, and most investors thought its results were good.
No major chain’s same-store sales are increasing as rapidly as those of DPZ. No major chain, in fact, is coming close. That trend should continue, and Domino’s can benefit from opening new stores, as well.
It’s adding stores to U.S. metro areas. That’s been a successful strategy despite fears that new stores might “cannibalize” existing stores. The company’s overseas business continues to grow, in terms of both comparable stores and new opportunities.
DPZ still expects its annual retail sales to rise 8%-12% over the next few years, with its global comparable sales increasing 3%-6% and its net store count rising 6%-8% annually. On the other hand, 8%-12% growth might not sound like much, since DPZ stock has a trailing-twelve month P/E ratio of 29.
But because of DPZ’s franchise model, 8%-12% revenue growth results in earnings and cash-flow growth that’s much higher than that. Store-level costs are borne by franchisees, enabling DPZ’s operating margins to rise faster than its revenue. And the leverage on Domino’s balance sheet further boosts its net margins. For 2020, for instance, analysts’ consensus estimate calls for a 9.8% increase in sales and an 18% increase in EPS.
The Risks and Rewards of DPZ Stock
The company’s 8%-12% revenue-growth guidance, then, suggests that its earnings easily could increase 100% or more over the next four or five years. Even assuming that the P/E ratio of DPZ stock drops in several years as DPZ matures, investors will still have an easy path to double-digit annual returns, including dividends. Any outperformance – or a continued willingness by investors to pay up for DPZ stock – sets up a path for DPZ to reach $500 and beyond.
But there are risks facing DPZ stock. The most obvious one is the potential for recession in the U.S. or in key international markets. Domino’s struggled during the financial crisis: its same-store sales declined 4.9% in 2008. But it clearly has a better business ten years later, and its emphasis on low price points could mitigate the macro pressures on it, particularly domestically.
There are two smaller concerns. The first is that on the whole there’s much more competition in the pizza industry than ever before. The rise of online ordering services like GrubHub (NYSE:GRUB) and DoorDash has allowed thousands of restaurants to offer delivery services, breaking pizza’s traditional dominance of that space. In turn, other chains now offer delivery, including casual dining giants like Brinker International (NYSE:EAT) and Dine Brands Global (NYSE:DIN).
But as that trend has accelerated lately, Domino’s sales don’t appear to have suffered. The company’s comp-sales growth has decelerated from 12% in 2015 to 6% in 2018. That’s not necessarily a surprise, however, given the tougher competition. But 6% still is more than enough growth to leverage expense growth and expand margins. And it hardly suggests that the company’s business model is facing an existential threat.
The Best Franchiser
The final risk is one facing the entire industry. Companies like McDonald’s and Burger King owner Restaurant Brands International (NYSE:QSR) have benefited from franchising more restaurants. That’s benefited MCD stock, in particular, as rising labor and food costs become the problem of the franchisees , not that of the corporate parent.
But as James Brumley pointed out last year, at some point franchisees won’t be able to handle that pressure any more. Carrols Restaurant Group (NASDAQ:TAST), the largest Burger King franchisee, shows the problem. Over the past three years, QSR stock is up 63%, but TAST has declined by almost 25% during the same period.
Domino’s franchisees, however, are doing quite well. The company pointed out in a recent investor presentation that its franchisees’ average EBITDA per store has soared in the past decade, rising from $49 million in 2008 to over $137 million in 2018. Franchise-level profits have stopped increasing lately, but they’re still positive, and franchisees’ margins still look quite healthy.
So, purely from a business standpoint, Domino’s looks like far and away the best pick among restaurant stocks. It has more opportunities to open additional stores than its large peers. DPZ can still take plenty of market share from its corporate rivals (and independent pizzerias). Its franchisees are happy. Since Domino’s is doing an awful lot right at the moment, the owners of Domino’s stock have little to complain about.
Given DPZ’s growth potential, DPZ stock is worth paying up for. With Domino’s Pizza stock now 15% cheaper than it was just a few weeks ago, the shares may be expensive, but they’re still attractive.
As of this writing, Vince Martin has no positions in any securities mentioned.