There aren’t a lot of restaurants benefiting from the novel coronavirus pandemic, but Domino’s Pizza (NYSE:DPZ) is one of them. Indeed, DPZ stock has rallied a sharp 46% so far this year.
Blowout earnings have helped. Same-restaurant sales increased 16% year-over-year in the company’s second quarter. I expect more big-time growth when the company releases Q3 numbers later this week.
This isn’t just a pandemic play, however. Domino’s is one of the best restaurant operators in the country. In fact, I’d argue that it’s one of the best businesses, period. Management is excellent. The strategy is on point. And Domino’s continues to simply crush its competitors.
DPZ stock certainly isn’t cheap. It trades at 32x next year’s consensus earnings per share estimate. But cheap isn’t a good thing in this market, where investors clearly have established their preference to pay up for quality. It doesn’t get much more quality than Domino’s, at least as far as investors are concerned.
The Stay at Home Tailwind Will Last
One argument against DPZ stock at the moment might be that the benefits of “stay at home” orders are going to fade. In fact, they probably already are fading.
Restaurants are reopening, which increases competition. Consumers who simply were sick of cooking in, say, May, didn’t have as many choices for delivery or pickup. In most cities, they can go out to eat again.
Domino’s second quarter results were impressive, but they’re not sustainable. All indications suggest a vaccine should be commercially available by next year. Normalcy is going to return. That may well pressure Domino’s results, or so a skeptic might argue.
But the tailwind for Domino’s should last beyond the second quarter for two reasons. First, the company no doubt is picking up new customers. Smaller, local competitors may well not have been able to manage the demand spike they saw in March and April. They certainly don’t have the online ordering options (or promotions) that Domino’s franchises do.
In some markets, diners simply didn’t have all that many options. There no doubt are thousands of Americans who this year ordered Domino’s for the first time in a long time. Many no doubt enjoyed doing so.
The second boost comes from the fact that the pandemic is accelerating technology adoption of all kinds. Domino’s is going to get more app downloads and more online users.
That growth helps sales. It provides a built-in customer base for promotions. Those customers also have an easier time ordering which makes them more likely to be return customers.
But it also helps franchisee costs. If employees are making pizzas instead of answering phones, then the franchise can either sell more pizzas or make more profit — usually both.
The Virtuous Cycle for DPZ Stock
That franchise-level growth drives benefits for Domino’s corporate. It creates a virtuous cycle.
Franchisees pay a 5.5% royalty on sales to Domino’s corporate. Higher sales for franchises thus mean higher profits for Domino’s. But those franchisees also contribute 6% of sales to national advertising campaigns.
So the better Domino’s does — and it’s doing very well right now — the more cash it has to spend to acquire new customers or activate existing ones.
We’ve seen this time and time again in recent years. Investors often believe that a stock that has soared has to stop gaining at some point. The opposite, however, often is true. Success leads to more success.
The franchise setup also adds leverage to the profits for Domino’s corporate. Again, the company makes its money off franchise-level sales. And each extra dollar of royalties comes with very little pre-tax cost.
In other words, Domino’s earnings can climb in a hurry. That’s a key reason why DPZ stock has been such a spectacular investment of late. It’s gained over 3,100% over the past decade as a turnaround has taken hold.
Domino’s kicked off that turnaround by running ads that admitted how bad its pizza used to be. It’s not running those ads anymore. The product is excellent, execution is on point, and the franchise model suggests earnings should continue to grow. 32x isn’t the cheapest multiple in the market, but it’s a fine price to pay for that story, and for one of the country’s best companies.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
