2023-08-07 16:28:15 ET
Summary
- DPZ delivered up their latest quarter, and we saw a bit of a mixed picture with EPS topping estimates but revenue coming in light.
- However, earnings estimates have historically been mixed, and this quarter it's just essentially a continuation of that.
- I believe the greater potential headwind for the stock price is the significant rise that it has experienced in such a short period which could pose some near-term pressures.
Written by Nick Ackerman.
Domino's Pizza ( DPZ ) delivered its latest quarterly results , and it was mixed. The second quarter beat EPS estimates but missed on revenue. The miss wasn't particularly large, but it showed a decline from last year of 3.8%. Conversely, EPS was up year-over-year by 9.2%.
They attributed the revenue decrease for the quarter as "primarily due to lower supply chain revenues attributable to a decrease in the Company's market basket pricing to stores, as well as lower order volumes."
Despite lower order volumes, the actual same-store sales improved. The U.S. same-store sales came in quite soft, with a growth of only 0.1%. However, international same-store sales did some of the heavy lifting here, with an increase of 3.6%.
To generate higher diluted EPS last year, over 9% came from gross margin expansion. A year ago second-quarter gross margin came in at 36.3% compared to this year's second-quarter gross margins of 39.5%. The total cost of sales dropped from 63.7% to 60.5% in the same period. Additionally, share repurchases helped add $0.07 due to a lower weighted average diluted share count. They're quite active in the share repurchases, and this isn't anything new.
YCharts
Share repurchases aren't the only way that DPZ returns capital back to shareholders. They also have an impressive dividend growth record. They've been increasing dividends consecutively for the last 10 years with an incredibly 10-year CAGR of 27.72%. The 3-year CAGR is a bit more modest at 17.33%, but still incredibly impressive.
One key area of concern for DPZ is its significant debt pile of $5 billion. Instead of continuing with repurchases, I was curious if they'd take that cash and pay down the debt instead. However, the interest expense actually declined primarily due to higher interest income on their cash equivalents.
So far, that means their debt pile hasn't been a headwind in this latest quarter despite the massive debt pile. This would be thanks to the staggered maturity schedule and fixed rates they locked in. This is something we discussed in our previous update, that it's something to watch but that they generate sufficient free cash flow not to be forced to refinance all the debt coming due at the now higher rates.
In fact, speaking of free cash flow, the company's FCF improved with this latest quarter significantly. In the last two fiscal quarters, FCF came in at $204.311 million compared to $120.751 million in the same period last year. Some higher Capex resulted in offsetting what would have been an even higher gain.
DPZ FCF (Domino's Pizza)
FCF in the first quarter came to $95.651 million, which meant this latest quarter had FCF at $108.66 million. Meaning quarter over quarter, we saw an increase in FCF of 13.6%.
They opened up another 197 stores globally to increase the total count as of June 18th, 2023, to 20,205. For the four trailing quarters, they've experienced 911 net store openings, with the majority of those coming from international store openings at 795.
Growth in the U.S. isn't at a standstill with 116 total franchised store openings, but it's certainly clear that store opening growth will continue to be driven by international as the U.S. market becomes mostly saturated.
Valuation
One of the bigger problems with DPZ right now is that it ran up significantly heading into this earnings report. It went from clearly being undervalued relative to its longer-term history to being nearly in its fair value range. At the same time, growth going forward is anticipated to slow from the last decade or so; that's been incredibly impressive. Combining that with the anticipation of higher interest rates on their debt and the fair value range could come down due to these factors. In other words, the fair value range might be a bit optimistic at the current moment due to higher growth in the past.
The catalyst for pushing the stock up so significantly was striking a deal with Uber Technologies ( UBER ) t o provide a new way for consumers to order pizza. However, instead of relying on third-party drivers, DPZ franchised store employees will still be making the deliveries.
Orders placed on the Uber Eats platform will be delivered by uniformed Domino's drivers. Uber One and Postmates Unlimited members will receive delivery with no charge on their Domino's orders within the Uber Eats and Postmates platforms.
That means they still have control of the making and end processes. They are simply going to be potentially gaining additional visibility from the users that utilize these apps. The benefit for the consumers that are subscribers is that they can now order delivery at no charge. Overall, I don't see a negative with such an arrangement. At the same time, I'm not necessarily as optimistic about the upside as some investors seem to have shown enthusiasm for pushing the stock to current levels.
Since our last update, which was fairly recent, performance has been impressive. I'd still give DPZ a "Buy" rating for the long term. The more tactical or short-term investor should probably be much more cautious at these levels though.
DPZ Performance Since Prior Update (Seeking Alpha)
Looking Forward
Missing quarterly estimates isn't anything too new for DPZ. They actually missed nine out of the last 16 quarterly estimates. Their EPS earnings misses are similarly spotty, with misses in seven out of the last 16 quarters. Looking forward, earning estimate revisions have been coming down over the last six months, but more recently, revisions have been inching up in the last month and three months.
Despite slowing growth, they aren't a dead company limping along by any means. Revenue has been continually climbing, and analysts believe it will continue over the coming years as well.
On the other hand, the company struggled last year for earnings and isn't expected to hit the peak EPS it achieved in 2021 this year. This was a pandemic darling, and in the price chart, we can see investors really pushed shares higher. Although analysts expect the company will top those results in 2024 and lead to new record earnings as well as revenue.
Given the outlook for some more modest growth going forward, the dividend growth would also be expected to slow down. The latest raise saw a boost of 10% when they took it from $1.10 to $1.21, which was a material slowdown from the previous boosts. The payout ratio is only sitting at around 36.3% based on this year's earnings, which are now 'half-baked' with EPS of $6.01 in the first half. Historically, Q4 results have been the largest contributor to annual EPS figures for the last six years - meaning that $13.34 is quite achievable this year.
I feel that it is ultimately a prudent move given the earnings slowdown experienced and higher interest rates. Leaving more cash set aside for ideally paying down debt or even share repurchases can leave them more flexible during this uncertain period. From their comment in the latest earnings report , they are comfortable with their current debt levels, so share repurchases look like they will continue.
Finally, the capital structure update. A debt leverage ratio of 4 times to 6 times is the appropriate leverage for our company and moves within the range depending on the level of interest rates. We have operated with this range of leverage for almost 20 years. In today's interest rate environment, you should expect us to use our free cash flow to make investments to grow the business, create strong shareholder returns through our dividend and share repurchase strategies and retire debt when it's in the best interest of our shareholders for us to do so. As always, we will be opportunistic if credit markets warrant additional borrowing or refinancing.
Conclusion
Growth going forward is expected to continue, and earnings should reach new highs in 2024. The latest quarter might have been mixed in terms of what analysts were expecting, but mixed earnings are quite normal for DPZ historically. Shares of DPZ have risen materially since our last update due to the Uber announcement. This can probably only add positives, but at the same time, there seemed to be too much enthusiasm pushing up shares so significantly in a short time. Caution in the short term is probably warranted, but I still believe DPZ can deliver over the long term.
For further details see:
Domino's Pizza: Long-Term Prospects Remain Solid