I Never Thought I Would See the Day
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I know that this story is not the novelty that it used to be, but I really never thought I would recommend Domino's Pizza (NYSE: DPZ). As proof that you can never count certain companies out, consider that years ago, myself and almost everyone I knew would've put Domino's in last place if you asked where we ordered pizza from. What changed is, the company focused tremendously on the taste of their product, did a great job advertising these changes, and is constantly winning business.
While the company's current earnings report was strong, the real growth that the company saw was masked by currency fluctuations. Much like its two primary competitors, Yum Brands (NYSE: YUM) and Papa John's Intl. (NASDAQ: PZZA), Domino's is the story of their domestic operations and international growth. While Yum Brands clearly has the advantage in international expansion capabilities and size, I honestly believe that product quality at a fair price is what determines consumer behavior over time. Domino's can compete effectively on price, and many people who previously would not have ordered from the chain have been impressed with the quality of the product.
With overall revenues down 2.3% and net income of 11.3%, the company's growth doesn't seem that impressive. However, because of the company's commitment to repurchasing shares, diluted EPS grew by 17.5%. Since many investors value stocks based on EPS growth, the share buybacks and net income growth bode well for the performance of Domino's stock. On the domestic side, the company already operates nearly 4,900 stores and only three net new stores were open during the quarter. However, sales increased 1.9%, primarily driven by 1.7% same-store sales growth. Clearly the company's domestic operations are at, or very close, to their saturation point. This means for Domino's to create value for shareholders in the future, they need to expand internationally.
Domino's International division saw sales increase by 6.7%. At first, I was very disappointed with this number, as mid-single-digit sales increases are not going to be enough to drive this company going forward. However, when you look at sales excluding currency fluctuations, they actually increased 13.8%. Combine this impressive performance with 5.7% same-store sales growth, and you can see how the company could grow earnings at a respectable rate going forward. Though the company has just over 4,900 stores internationally, the opportunity for growth is much higher, primarily due to faster growing economies and greater populations. You can see that the company believes this as well, as Domino's opened 111 new stores internationally. The company also indicated their willingness to continue opening a significant number of international stores for the next several years. The company will face stiff competition from the Pizza Hut chain, as well as the international expansion of Papa John's. However, if the company maintains its current high-quality offerings, I believe that customers, not the size of the company, will determine the ultimate winner. The only thing that stands in the way of Domino's expansion is the company's balance sheet.
If there's one reason to be concerned about Domino's as an investment, it has to be the company's long-term debt situation. With over $1.5 billion of long-term debt, this wouldn't be a huge deal if the company's cash and investment balances were staying flat or increasing. However, with cash and equivalents dropping by just over 50% and long term debt increasing by about 6% in the last few months, the numbers are going in the opposite direction that investors would like. The company did increase its operating cash flow by over 30% on a year-over-year basis. In addition, Domino's generated over $50 million in free cash flow. However, this level of debt could get in the way of the company's future expansion plans. With that being said, Domino's looks like a strong contender for investors' dollars if they can manage their balance sheet appropriately.
The company that most people compare Domino's to is Papa John's, because both companies are fighting the same battle as second-tier players versus Pizza Hut. When it comes to growth, Papa John's and Domino's are expected to grow earnings by nearly the same amount over the next few years. However, Papa John's sells for a P/E ratio of just over 20 versus a ratio of closer to 17 at Domino's. Where Yum Brands is concerned, they are the only one of the three companies that pays a dividend. While the stock also sells for a P/E ratio of over 20, the company's 13.68% growth expected and this 1.7% dividend make the comparison a little tougher. For investors in Yum Brands, one issue is that for a company with almost 38,000 restaurants, how realistic is a better than 13% earnings growth rate? Also, Domino's has beaten earnings estimates in three of the last four quarters, which means their future growth rate could be understated. It's a close race between Domino's and Yum Brands, but similar to the taste of each company's pizza, I like Domino's better.
MHenage 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.