Domino's Future Plans Are Convincing Enough To Earn It A Buy Rating

Sep. 2.14 | About: Domino's Pizza, (DPZ)


Domino’s latest quarter brought an improvement of 8.8% in the top line. Earnings improved by 17.5%.

The introduction of new product offerings in the domestic market is proving to be successful, given the improvement in domestic growth rate. The idea can be implemented internationally as well.

Expansion in the emerging markets, together with the introduction of digital channels, should help in driving the sales momentum upward.

Domino's Pizza Inc. (NYSE:DPZ) share value has gone up by 23% in one year. The company's falling reliance on the domestic market, with over 50% revenue being generated abroad, is something that should please investors in the future. This is because the company has given on average a 5.6% same-store sales growth rate abroad for the past 20 years. As more people join the middle class globally, this trend is likely to sustain.

In this article, I will discuss the future prospects of Domino's in terms of its revenue and profit potential. A good way to begin is to determine the financial strength of the company, through its recent quarterly performance.

Second Quarter

During the period, Domino's revenue increased year over year by 8.8% to $450.5 million, beating what the analysts expected. Compare this to Pizza Hut, whose same-store sales in the US have fallen for seven consecutive quarters. For Domino's, the increase was driven by a growth in comparable-store sales, both in the domestic and the international markets. Greater business in supply chain segment, owing to higher commodity prices and increased volumes, also pulled up the top line.

However, the operating margin declined by 50 bps to 29.9%, as higher food and commodity prices brought pressure on costs. Cheese, which is a major component of pizza, has continued to become more expensive with time. During the last quarter, the price of cheese rose by 24.3% to $2.20 per pound. This trend should continue in the future as the ongoing drought in California is going to bring a material effect on dairy, vegetable and fruit prices.

Despite the increase in cost, Domino's has still been in a better position as compared to its rivals such as the Cheesecake Factory (NASDAQ:CAKE) that has been affected more negatively by the food price hike. The company managed to bring an increase of 17.5% in earnings per share as the figure rose year over year to 67 cents.

The company's future plans to sustain the earnings momentum are convincing because they are going to introduce, in international markets, a system which is considered staple in the domestic market. This, together with the product offerings that are being positively embraced by the consumers, and the rebranding strategy, hold the key for future earnings growth. I will be discussing these one by one.

In the home market, Domino's has been running a new pizza menu with its specialty chicken, which is boneless chicken covered with pizza toppings. The product has already been embraced by the customers and was able to provide better margins for franchisees in the latest quarter. Other than margins, as a result, the company's domestic comparable-store sales growth rate of 5.4% improved by 50 bps sequentially as compared to 4.9% in the first quarter. This product offering could be expanded to the international markets, and similar growth rate expansion may be reaped abroad as well.

Moving towards the international market, this is where the company should drive its major sales for the future. The growing middle-income class is already a reason behind this. It also partially explains why the international stores provided top-line growth rate of 7.7% in the latest period. This was higher than both the previous quarter's rate of 7.4% and the year-ago level of 5.8%.

Of precise importance is the expansion in India. The country tops the list of emerging markets with a potential of adding 451 stores to the present level of 749. In just four years, Domino's has increased its store count there to more than double. The company added 150 stores in fiscal year ending March of this year. If the same pace continues, the company should reach 1,200 stores by 2017. With growing comparable sales figure, this should reap in additional revenue.

Apart from India, the introduction of technology that is already present in the developed economies should facilitate the process of ordering pizzas in the emerging markets. For example, online ordering, through debit or credit cards, is still not widely available in countries such as Pakistan. Since 45% of Domino's sales now come through the digital channels, the introduction of digital measures in the remaining countries will further complement the expansion being carried out.

A recent example is South Korea, where the company's latest promotions focused on the digital ordering of the new products that helped in driving a better performance. Even in the domestic market, the company is making progress. Domino's launched its iPad app in May that brought over $1 million in sales during its first four weeks alone. Since then, Domino's has also become the first company to launch voice ordering through iPhone and Android apps. The voice ordering is similar to Siri on an iPhone.

Bottom Line

The company's international operations promise significant growth potential. I can say this because the company has already given international same-store sales growth for 82 consecutive quarters. Domino's brought 122 new stores in the international market during the latest quarter, leveraging the growing comparable sales rate. I believe the company's digital ordering system and its foray in the specialty chicken category will also help it in sustaining the top-line momentum. While food costs are expected to increase by 4% to 6% in 2014, these shouldn't be enough to bring a dent to the earnings.

The company has actually revised up its earnings guidance over the past month. Furthermore, the long-term growth rate of Domino's is currently at 15.2%, which is impressive. Also, the company will be paying a dividend of 25 cents per share to investors who are on record by the 15th of this month.

Running a quick valuation, I have the next-year earnings forecast of $3.34. Multiplying it with the industry's PE ratio of 28.4 gives an intrinsic value of $94.8. This provides an upside potential of 25% at the current market price. Therefore, if you want to buy a stock with strong dividend and solid upside, Domino's is the company to consider. It holds a buy rating.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.