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Domino's Pizza Is Primed For Big Gains

May 10, 2014 | About:
Vinay Singh

vinaysingh

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I don’t remember the number of Sundays I have craved for a slice of the yummy cheese-burst pizza from Domino’s (DPZ). Fondly termed in the industry as Pizza delivery expert, this food chain has not only pleased its customers with great taste but also investors with massive returns. Its stock has almost doubled over the past 12 months as a result of sustained growth in earnings and increasing confidence of investors. Domino’s has also created reasonable value for shareholders by ensuring a consistent dividend policy.

Specialization and Expansion are the key drivers

When a company operates in a highly competitive industry, it can sustain and grow only by creating a separate identity for itself (an advice I have got throughout my life). Well, Domino’s has successfully implemented this dictum by becoming the go-to chain for offering unparalleled service when it comes to pizza delivery. The company’s strength was clearly visible in its second quarter results wherein it reported an EPS of $0.57 per share, up 21.3% over the prior year quarter. Its international division reported same store sales growth of 5.8%. Another thing that has aided Domino’s growth is its aggressive expansion strategy. Consider this; the international division of Domino’s grew by a whopping 101 stores in the second quarter alone.

Hiccups in certain countries

While I appreciate Domino’s aggressive expansion, the performance of some of its franchises in major countries is worrisome. Reportedly, a couple of directors in Domino's UK offloaded sizable stake in the company that was preceded by a stake sale by the CFO of the company. It is believed that a poor show in the first half of the year could have propelled these executives to exit at a good valuation. In India, Jubilant Foodworks that runs the Domino’s franchise reported a massive decline in the growth of same-store sales from 22.3% to 6.3% in Q1, 2013. In order to beat the slowdown in demand, Jubilant introduced new products as well as entered new regions.

Though the stock has not been punished on the U.S bourse because of the news, a continuing phase of poor results would definitely have substantial effect on Domino’s business. Since the company is highly leveraged with a long term debt of approximately $1.52 billion (as on 16thJune, 2013), a decline in revenue would mean lesser value for shareholders. If we consider this scenario in simple numbers, Domino’s free cash flow is approximately 1/4th of its debt while its current ratio is at 1.32. Though the company is not facing any serious liquidity crisis, it sure has to generate more cash going ahead to justify the enormous debt taken for financing operations.

Papa John’s is as good as Domino’s

Only on the basis of certain technical metrics, Papa John’s (PZZA) portrays a better picture than Domino’s with a current ratio of around 1.5 and total long term debt of around $0.13 billion. One of the arguments that surfaces in this regard is Domino’s store count and presence across a wide range of markets. Also, once we take a look at the share price movement of both these companies, Papa John’s is dwarfed with a growth of meagre 24% as against Domino’s 82% growth in the last 12 months.

Earlier, Papa John’s was not in favour of investing huge money in promotion but with the increasing competition, it has picked up pace in advertising. It was the brand most identified by NFL fans as NFL sponsor. To add to the celebration, it was also ranked #1 in customer satisfaction in America.

Even though the company lacks humongous international presence, this data surely conveys its herculean power in the U.S. and I think that this lack of wide presence is more of a growth opportunity than a negative point. Papa John’s consistent record for delivering strong results and a tonne of opportunities ahead make it a ripe investment.

Yum! Brands does have some problems

Yum! Brands (YUM), the holding company of popular brands like KFC and Pizza Hut has been facing constant issues with its KFC brand in China. The media in the region has tainted the brand for using illegal drugs for fattening chicken besides other allegations. While Yum has made all efforts to meet quality standards in order to sustain growth in this key market, it has limped on ever since the first allegation. Yum has also not been the best investment for investors as it churned out total returns of 11.8% over the last year as compared to S&P 500 total return of 24.7%.

Apart from low returns, another downside to this stock is volatility. A look at its share price movement reveals a high frequency of swings in the last 12 months with a net capital appreciation of just 11%. Thus, an investor is better off investing in a stable dividend paying stock like Domino’s than Yum!

Domino’s is the obvious choice

A couple of months back I read an article on how the CEO of Domino’s India franchise designed the entire delivery system in order to deliver pizzas efficiently and without violating the legislation of the country. It is this planning and dedication that has helped this company in becoming the pizza delivery champion across the globe. This title that Domino’s has earned is a huge advantage that will continue to pay off handsomely in the future.

To conclude, I am not asking investors to disregard certain concerns over the financial health of the company or challenges it is facing in big markets. Domino’s is a fundamentally strong company that has effectively tackled competition to sustain value for shareholders, which is the primary reason that one should pick it as an investment in this industry.


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Comments

Dr. Paul Price
Dr. Paul Price premium member - 6 months ago

Why did you avoid giving the current price on any of the stocks mentioned?

How can anyone know if DPZ or the others are good or bad investments without knowing their present day quotes?

What do you think DPZ is worth? How did you come up with that target price?

You spoke about DPZ's extremely high debt level but then called it "fundamentally strong". Those things do not really go together.

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