2023-06-02 12:41:52 ET
Summary
- Domino's Pizza shares have been on a downward slope for the last couple of years now as the positive impact of the pandemic wore off.
- However, we've now gotten to the point where shares look attractively valued for a long-term investor.
- This is a shareholder-friendly company that has focused on dividends and buybacks.`.
Written by Nick Ackerman. This was originally included in the monthly Cash Builder Opportunities portfolio fair value update piece.
Domino's Pizza ( DPZ ) saw its fair value estimate drop since our last update, based on Morningstar's valuation. However, even with the reduction that was citing "soft traffic and delivery headwinds," it would indicate some substantial upside.
Overall, Morningstar isn't alone, as Wall St. analysts rate the stock a "Buy" with an average price target consensus of $347.46. That isn't quite as rosy as the Morningstar valuation, but it indicates some optimism.
DPZ was a pandemic darling as it benefited significantly from consumers being stuck at home during lockdowns. There was also plenty of stimulus to keep consumers flush with cash. They've more recently been coming down from the pandemic benefits, and the share price has certainly shown this to be the case. The stock went from extremely overvalued to now being well below the fair value estimate based on the historical P/E.
An added benefit was the fact that they could ramp up debt while simultaneously doing significant buybacks.
They are actually still doing these buybacks, but they've slowed down. The latest quarter saw the repurchase and retirement of around 100.5k shares worth around $30.1 million. They still have $380.3 million in share repurchase authorization, which could make even more sense now that the share price is quite cheap.
Doing these repurchases helped the companies' EPS grow even further and faster. Debt can often be seen as a negative for the company, but thanks to its lean business model and free cash flow generation, it shouldn't really be a problem. 99% of DPZ's stores are owned and operated by franchisees. They own enough stores to get a good sample to test markets, and that is about it. In total, they had 20,008 restaurants at the end of March 26th, 2023, with 285 company owned.
They noted in the latest quarter that debt once again trickled down to $5.01 billion due to repayment. They provided an FCF of $95.651 million for the latest quarter. Net interest expenses in the last quarter came down to $44.156 million from $46.823 million previously. They are constantly buying back shares, but as of the latest data of shares outstanding against the current quarterly dividend, that should see an outflow of $42.760 million for dividends. The FCF, in this case, easily clears the requirements of the company for meeting its debt obligation.
The debt obligations coming due in the next year and two years are minimal. They will have no problem paying this off. However, it is in year three that they might have a bit of a problem. In this case, that's an eternity and probably a recession away. The main risk here is that in a few years, rates may not come down substantially to provide cheaper debt. Therefore, we could see them have to refinance a good portion of this at even higher rates.
With the two factors of debt becoming more expensive and the pandemic boom over, DPZ has been returning to a more normalized environment. Thus, why we've seen the price return to a more normalized level.
However, what might be interesting to note is that there was still some permanent and sticky EPS growth during the pandemic years. It hasn't given all that profit back. 2022 only saw less than an 8% decline in EPS. At the same time, the stock price has fallen back to those pre-Covid levels despite higher earnings.
Going forward, we even see that earnings are once again expected to grow. By 2024, the company is already expected to top the 2021 EPS figures. All things being equal, that could indicate that the stock is undervalued if you are a longer-term investor.
The latest quarter saw EPS come in at $2.93, above the $2.50 they reported a year ago. They noted that the quarter saw the benefit of lapping Omicron in 2022 as well "as the benefit from a boost week in 2023..." A "boost week" is when they offer pizzas at 50% off. Additional help for earnings came from some margin expansion, which outpaced the negative impacts of foreign exchange rates, as they noted in their earnings call .
...efficiencies in our cost structure as we continue to drive recovery in margin. We saw year-over-year improvement in our operating income margin, which grew by 100 basis points versus Q1 2022. This was despite foreign exchange rates having a negative year-over-year impact on operating income margin of approximately 40 basis points during the quarter.
They also saw a 3.6% same-store sales growth of 3.6% for their U.S. stores, with international same-store sales growth at 1.2%. Softer international, but that's where most of their growth will come as they have more room to expand - the last quarter then noted that global net store growth was 128. That included 22 stores in the U.S. and the remaining 106 internationally. As a franchisee model, they have an easier time expanding their store count.
It might also be interesting to note that they actually didn't take a hit on revenue at all. Meaning, they were able to pass costs on to consumers without taking a sales hit. Inflation has been a headwind for the company as they had to deal with higher costs for both food and labor. These cost pressures should be letting up as inflation comes down to more normalized levels.
Speaking of normalized levels, these had come about with interest rate increases. Those interest rate increases are very likely to cause a recession. History tells us this is the case in almost every situation when the Fed raises.
With a potential recession on the horizon, that could certainly throw a wrench into their plans. But I'd argue that DPZ might not see quite the hit that some might believe. I enjoy DPZ, but it's not like we are talking about some fine dining. Their $6.99 "choose any 2 or more" type deal is something that can be seen as a value. One can feed a family for under $15 bucks with a pizza and some cheesy bread or whatever side. Fair to say, that's a pretty good value and could be something that could be enjoyed, even during a recession.
Conclusion
Add this all up, and that's why I believe that DPZ stock is still in a strong position and should be considered by long-term investors. Even better now is that I believe shares are fairly cheap, given the outlook. At a very slim payout ratio of around 36% and strong FCF, they have a safe dividend with a strong history of repurchasing shares. The dividend growth may slow in the coming years as things start to normalize, but they are still likely to keep on being shareholder friendly as they've historically been.
For further details see:
Domino's Pizza: A Dividend Growth Machine At An Attractive Valuation