Editor's Choice

Will this Pizza Delivery Expert Deliver a Good Return?

Abir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The other day I was watching an interesting cricket match, when suddenly my doorbell rang: it’s the pizza boy!! Everyone knows that a pizza makes a good round of cricket more exciting! Domino's Pizza (NYSE: DPZ), the pizza delivery expert, is always there for its valued customers to deliver happiness in the form of delicious pizza pies.

Domino’s Pizza is an international pizza delivery corporation in the United States, and operates its business in three segments: domestic stores, domestic supply chain, and international. During the past five years, shares of Domino's have returned about 120%, which compares favorably to the S&P 500’s return of -6% over the same period. Even compared to other pizza, fast food, and casual dining restaurants, Domino's stock is outperforming.

 For example, Papa John's (NASDAQ: PZZA), Yum! Brands (NYSE: YUM), McDonald's (NYSE: MCD), and Darden Restaurants (NYSE: DRI) returned 95%+, 90%+, 60%+, and 25%+, respectively, during the past five years. In fact, the one company that’s stock return is similar to Domino’s is Chipotle Mexican Grill. In this article, we will go through Domino's fundamentals and valuation, the company's growth strategy, and competitive position and reach a conclusion if Domino's stock outperformance is sustainable.

Fundamentals and Valuation of the Company

During its latest quarter ended June 17, 2012, the recognized world leader in pizza delivery reported strong results. It opened 114 new stores (111 international and 3 domestic) and registered international and domestic same-store sales growth of 5.7% and 1.7%, respectively. This marked the 74th consecutive quarter of international same store sales growth. While the company has a significant amount of debt on its balance sheet ($1.6 billion), it is able to meet interest obligations as it had $50 million in free cash flow during the first two quarters of the current fiscal year.

<img src="/media/images/user_13778/dominos-1_large.JPG" />

From the above chart, we can see that in terms of profitability (operating margin), Domino's seems to be worse than the major fast food chains such as Yum! and McDonald's, but relatively better compared to Papa John's and Darden. Domino’s operating margin for the first half of the year was 17.4%, a 100 basis points higher than its operating margin in the same period last year.

Based on price to estimated current fiscal year earnings (P/E) ratio, Domino's common stock is valued similarly to Papa John's and Yum!, but overpriced compared to McDonald's. Domino's P/E to growth (PEG) ratio is at 1.37, among the lowest in the sample group.

Finally, in terms of returning cash to shareholders, Domino's has one of the best records. As part of a recapitalization, in April 2012 Domino’s paid a $3.00 special dividend per share. Also, it has authorized $200 million for the repurchase of stock as of July 20 (that’s about 10% of its current market capitalization). In addition, 15% of Domino's shares are held by company insiders, and a high level of insider stock ownership (but less than majority control) indicates that management's and shareholders' interests are aligned.

Company’s Growth and Competitive Environment

This pizza delivery company is actively growing in terms of products and geographic regions.

<img src="/media/images/user_13778/dominos-2_large.JPG" />

Graph from Dominosbiz.com (August 2012 Investor Presentation)

From the above graph you can see that during the 2007-2011 period, the company's number of international net units increased more than that of Papa John's and Pizza Hut (Yum!) over the same period. Recently, the company opened its 10,000th store, located in Istanbul, Turkey, and its first ever store in Nigeria. In terms of productivity growth, Domino's continues to offer new products; so far this year the company has launched handmade pan pizza, gluten free pizza crust, and parmesan bread bites.

Due to Domino's larger size, the company is able to offer a standalone smartphone application for ordering pizza. Its growth and competitive position are also helped, and by meeting USDA nutrition guidelines. This has allowed the company to grow its lunch offerings at public schools. Domino's now serves over 3,000 schools in 37 states, up from 1,100 schools in the beginning of 2011. The National Fire Protection Association partners with Domino's, and uses its growth to deliver important fire safety messages to people.

To End Up With

The company's strengths can be seen in multiple areas, such as its solid stock price performance, growth in earnings per share, an increase in net income, largely solid financial position with reasonable debt levels by most measures, and good cash flow from operations. Domino’s also has a strong brand, and the number of stores it has opened internationally (and continues to open) shows that it is the leader of the underdeveloped pizza delivery business.  These strengths make Domino's Pizza a tasty investment choice.

<img src="/media/images/user_13778/dominos-3_large.JPG" />

​Graph from StockCharts.com

Domino's shares are not cheap, but they still offer  good value and an opportunity to participate in the company's profitable growth. The company has 22% of the domestic market for pizza delivery, 52%+ of its revenues coming from overseas, a well accepted brand, efficient supply chain distribution, and new product offerings. All this should help Domino's Pizza weather any inflationary or economic headwinds relatively well. I am pretty bullish about this pizza delivery corporation, so investors, take a bite of this good-return filled pizza.

abirk has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants, McDonald's, and Papa John’s International. Motley Fool newsletter services recommend McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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