With much of the U.S. and significant portions of the world under some form of social distancing requirements, companies in the restaurant sector often aren’t allowed to offer dine in service. This is going to have a significant impact on business, though companies are allowed to offer carryout and delivery services.
Given these circumstances, its not a surprise that so many restaurants are struggling. Some have already made it known that they won’t be able to pay the rent on time and others have already cut dividends in order to preserve capital.
One restaurant company that is flourishing despite these conditions is Domino’s Pizza, Inc (DPZ, Financial). The company’s business model was already prepared for increased delivery. Delivery accounted for 55% of all transactions and two thirds of sales during the quarter, with carryout contributing the remainder. Unlike dine-in restaurants, Domino’s didn't have to shift its business model all that much, giving it a leg up on the competition.
The company’s strength can be seen in its most recent earnings report. Domino’s reported first quarter earnings on April 23. The company earned $3.07 per share, which was $0.72 higher than the analyst community had expected. EPS increased 40% compared to the previous year, aided by higher royalty revenues, lower share count and a tax benefit related to equity compensation. Revenue grew 4.4% year-over-year to $873 million, slightly higher than estimates and up almost 6% in constant currency.
U.S. same store sales grew 1.6% compared to 3.9% growth in Q1 2019, while international sales improved 1.5% compared to 1.8% growth in Q1 2019. Same store sales have now increased for 36 consecutive quarters, while international stores have seen 105 consecutive quarters of sales growth. The company temporarily closed approximately 1,750 stores in international markets in response to the pandemic.
Over the last four weeks of the quarter, which ended March 31 and occurred during the issue of many stay at home orders, Domino’s U.S. comparable sales accelerated 7.1%. Domino’s already accounts for 49% of U.S. pizza sales, so this growth could potentially mean that company will control more than half the pizza delivery market soon (depending on competitors' results). Domino’s saw its sales spike by nearly five times the quarterly average and said it needs to hire new team members to meet the growing demand for its increase in demand. The company is looking to hire as many as 1,000 new employees in the Chicago area alone in order to keep up with demand.
Domino’s is also aggressively increasing its store count. The company added a net 69 new stores during the quarter, giving it 17,089 locations worldwide. The pizza delivery industry contains many players, with independent operators accounting for half of sales. These locations may struggle in the current environment, especially if they primarily operate a dine-in option. With its size and scale and easy to use technology for ordering, Domino's is likely to be a beneficiary of a slowdown in the independent pizza business.
While Domino’s increased its dividend by 20% for the March 30 payment, investors may fear that its dividend is at risk for a cut or suspension like other restaurant companies. However, these fears should be assuaged by looking at the payout ratios. The annualized dividend of $3.12 would consume just 30% of predicted EPS for the year, which is lower than the 32% payout ratio that the company has averaged since it began paying a dividend in 2013.
Free cash flow paints a similar picture. The company distributed just under $31 million in dividends during the quarter while generating free cash flow of $78 million. This gives Domino’s a free cash flow payout ratio of 40%.
Dividends aren’t the only way the company returns capital to shareholders. Domino’s has retired an average of 3.6% of the annual share count between 2010 and 2019. The company also bought back 271,000 shares in the first quarter at an average price of $294, which is 25% below the current share price as of the writing of this article. Domino’s hasn’t bought back any shares since the first week of January, but does have $327 million, or about 2.6% of its current market capitalization, remaining on its repurchase authorization.
The issue that some investors may have with shares of Domino’s is its valuation. Using the current share price of $367.29 and analysts’ estimates of $10.51 in EPS for 2020, Domino’s trades with a forward price-earnings ratio of 35. This is much higher than the S&P 500’s current average price-earnings ratio of 20.3.
Domino’s did pull its longer-term guidance due to the uncertainty regarding the pandemic. Previously, the company had expected 7% to 10% annual sales growth over the next two to three years. If Domino’s is able to show U.S. comparable sales growth for the rest of the year anywhere close to the rate of the last month of the quarter, then the company might be able to achieve its previous growth targets.
In conclusion, comparable sales for the first quarter were below that of the previous year, but Domino’s performed much better in the U.S. than its restaurant peers in the month of March. This is a very positive sign given the struggles of so many in the restaurant sector. The company is also expanding both domestically and internationally. For these reasons, I find Domino’s Pizza to be an attractive buy opportunity.
Author disclosure: the author is not long Domino’s Pizza
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