A recent business article, "Domino's sold almost $2 billion worth of pizzas in the past year," discussed how Domino's Pizza (DPZ, Financial) grew its sales and other financial numbers that make it appealing to prospective investors.
(Domino's Pizza, Annual Filing)
Domino's Pizza
Domino's Pizza was founded in 1960 by brothers Thomas and James Monaghan. The two borrowed $900 to purchase a small pizza store in Ypsilanti, Michigan. The company officially became “Domino’s Pizza” in 1965 and opened its first franchised store in 1967. Its first international stores opened in Canada and Australia in 1983.
(Domino's Pizza, Annual Filing)
In its recent annual filing, Domino's Pizza, having 12,500 locations in over 80 markets worldwide, had identified itself as the second-largest pizza restaurant chain in the world. The pizza company said it sells more than 1.5 million pizzas each day. Domino's generates sales and profits in several ways. The company charges royalties from selling food, equipment and supplies to franchisees (mostly in the U.S. and Canada), and by operating a number of its own stores.
Also, Domino's said it had been structured with a leveraged balance sheet and has completed a number of recapitalization events since 1998. In fiscal year 2015, Domino's had a "2015 Recapitalization," which included an issuance of $1.3 billion of fixed rate notes and the repurchase and retirement of $551 million of previously outstanding fixed rate notes. In that year, Domino's had total debt of $2.2 million and total equity of -$1.8 million. The company had a retained deposit of $1.8 million, therefore resulting into the negative equity.
The negative equity definitely would chase off any conservative investors looking at Domino's. Regardless, Domino's defied this assumed perspective and actually outperformed the broader Standard & Poor's 500 year-to-date return with 32% while the latter had returned 6.85%.
Sales and profits
In the second quarter, Domino’s delivered a 12% sales growth to $547.3 million and 7.3% profit growth to $49.26 million year on year. The company also beat Wall Street estimates recently and in five out of eight quarters.
In 2014, organizational changes took place and Domino’s now reports the following three business segments: Domestic Stores, Supply Chain and International Franchise.
According to its filing, the Domestic Stores segment includes operations with respect to all franchised and company-owned stores throughout the contiguous U.S. The Supply Chain segment primarily includes the distribution of food, equipment and supplies to stores from the Domino’s supply chain center operations in the U.S. and Canada. The International Franchise segment primarily includes operations related to the company’s franchising business in foreign and non-contiguous U.S. markets.
In the three business segments, Domestic Stores grew most at 16%. Domino’s has the highest profit margin found in its International Franchise segment at 80% in 2015, followed by Domestic Stores segment at 36% and Supply Chain segment at 9%.
Cash, debt and book value
As of June 19, Domino’s had total cash of $22.3 million and total debt of $2.21 billion. The company had a negative book value of $1.9 billion.
Cash flow
(Domino’s Pizza Cash Flow in 2015, annual filing)
In 2015, Domino’s grew its cash flow from operations by 51.7%. Discounting the 18.58% profit growth that occurred, Domino’s also grew its accounts payable by a good margin leading to an overall improvement in its cash flow.
Also, Domino’s paid $63.28 million in capital expenditures leaving it with a good free cash flow of $228.5 million. Despite the endeavoring balance sheet, Domino’s had ample of cash to provide its shareholders dividends and also share repurchases. The pizza company had actually been able to provide both shareholder friendly activities in the past decade, except during the Great Recession. Going back, Domino’s paid $80.33 million in dividends and $738.6 million in share buybacks. Further, Domino’s reduced its debt by $564.4 million and issued $1.3 billion in debt.
I initially assumed that Domino’s would probably then be valued by Mr. Market by its free cash flow. Nonetheless, the company was valued at 42 times its free cash flow while its industry has a median of 22.96 times
Conclusion
Delivering consistently growing sales, profit and free cash flow figures over time may be the reasons why Domino’s has been  much appreciated by the market. In a five-year average, the company grew these figures by 7%, 17% and 22%. In a quick dividend review, the company has a trailing 12-month dividend yield of 0.94% with a payout ratio of 37%.
In contrast, the pizza company’s balance sheet still is stated at negative book value. Are investors turning a blind eye on this intentionally and believing the company would overcome this decade long negative equity? Domino’s current valuation also did not provide any sense of margin of safety if there had to be one in place.
Disclosure: I do not have shares in Domino’s Pizza and do not plan to initiate a long position this week or the next.
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