Why Domino's is a Good Buy
Gayatri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently, Domino’s (NYSE: DPZ) reported better than expected 2Q results. Its EPS of $0.47 exceeded consensus of $0.46 with lower input costs, highlighted by a 12% decline in cheese prices as the major driving force. Domino's also recently refinanced its debt and paid a $3 special dividend. Domino’s stock price has gained ~12% in the last month. The following are the key reasons I'm bullish on the stock and believe this upward momentum will continue.
Growth-Oriented International Business
International same store sales increased 5.7% in Q2 beating the consensus estimate of 4.8% on top of international store count growth of more than 2% (by 111 units). This 74th consecutive quarter of positive same store sales growth has made DPZ's international model irrefutable. At the end of 2Q, the company operated a total of 4,901 domestic stores, while international franchised stores totaled 5,023. We expect the international division to continue to grow net units at a high single-digit rate while continuing to see mid single-digit same-store sales growth in the coming years.
Being Smarter with the Smartphones
Adoption of latest technologies is an added advantage that gives Domino’s a competitive edge over small competitors. Mobile Apps orders have improved accuracy, and while these applications may or may not specifically allure traffic, it elevates DPZ'a reputation for prompt delivery. Introduction of technologies enhance the savings in labor and are likely to provide national companies an edge over peers and drive positive results in the near term.
Regional chains still have ~25% market share and Domino’s, along with the other two top chains, Pizza Hut (owned by YUM! Brands (NYSE: YUM)) and Papa John’s (NASDAQ: PZZA), is likely to benefit from vulnerability of regional chains to the technology edge of the leaders (apps, IT support, etc).
Declining Cheese Prices making Investors' Pockets Obese
Although a hike in commodities like grains has adversely affected the prices of cattle and milk over the last few weeks, cheese prices (about 30-40% of COGS) have managed to escape the anticipated rise. Keeping seasonal variability in background to compare prices, current cheese prices are around $1.75/lb as compared to around $2.15/lb during the same period a year ago. As a result, the company reiterated its 1% to 2% commodity inflation expectation for the year due to restrained cheese prices and fixed pricing for 35%-40% of expected purchases.
Also, given the heavily franchised nature of DPZ’s system, the company remains somewhat immune to the variable cost for cheese. The lower price of cheese will also improve margins of the franchisee and will eventually allow them to introduce enticing offers in the menu that will implicitly affect the traffic and sales.
Two major concerns investors have with Domino’s is its high level of debt and European exposure. I believe the company’s highly franchised business model that provides pertinent free cash flow should diminish concerns about the company’s debt levels. In terms of European exposure, Europe constitutes 20% of DPZ's international store count. Although it is somewhat worrisome, I believe the company will be able to navigate tough European macros given the other secular drivers in its business.
Both developed and developing markets presents good opportunity for Domino’s delivery-based business model. Growth drivers like unit expansion, same store sales increases, margin improvements, and debt pay down continue to add weight to our bullish thesis. Thus, we recommend Domino’s as a good long-term investment.
GayatriSharma has no positions in the stocks mentioned above. The Motley Fool owns shares of Papa John’s International. Motley Fool newsletter services recommend Yum! Brands. 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.