Domino's Pizza (DPZ) has been one of the most surprising stocks over the past two years. To put this in perspective, Domino's stock has matched Apple (AAPL) stride for stride. Although since Domino's special $3 dividend the stock has failed to continue moving higher. One reason for this is that investors may be concerned that Domino's is handing out cash despite having considerable debt obligations ($1.45 billion as of January 1, 2012.) The positive aspect of this debt, if a positive can be found, is that 99.94% of this is labeled as long-term debt.
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Chart courtesy of Yahoo.com.
There are three reasons Domino's stock has plenty of upside from the present level. The first is stronger restaurant growth than expected via Yum Brands' (YUM) first quarter 2012 earnings report. Another indicator that Domino's stock will be heading higher is an investment by Guggenheim Partners in Domino's asset-backed securities (ABSs). The third reason is three common technical indicators: SMAs, RSI, and Bollinger Bands (BBs).
Yum's Earnings Report
Yum reported earnings after the close of the regular trading session on Wednesday with income and revenue ahead of expectations. Yum also increased the company's EPS guidance for 2012. The biggest pitfall for Yum was the inclination that Chinese growth is slowing down. Moreover, Chinese labor and commodity costs caused Yum's Chinese margins to decline to 23.6%. This is important because the majority of Chinese sales can be contributed to KFC and Pizza Hut. And Pizza Hut is one of Domino's closest rivals.
Yum's Chinese report is important for Domino's investors because this indicates that Domino's margins may decline as well. However, one difference is that Domino's franchises over 91% of domestic stores and likely the same or more stores are franchised throughout the world. Therefore commodity costs can be placed on the franchise owner. This does not mean Domino's will not be effected by commodity price changes, but it does help the overall bottom line.
If commodity prices do not effect Domino's as strongly as Yum, then Domino's will present investors with a surprisingly strong first quarter earnings report. This would not surprise me to see this for a couple reasons. The first is that Domino's has been swaying more costumers with several impressive advertising techniques and an overall better pizza. The second reason is that Yum indicated that worldwide growth is strong. The only hiccup is operating costs are increasing. Therefore with Domino's heavy expansion we may see a tremendous amount of revenue. Income will be dependent upon commodity costs, but the higher the revenue the higher the probability net margins will increase.
Guggenheim's ABS Investment
At some point in the first quarter Guggenheim, a fixed income specialist, purchased ABS from Domino's that are secured by royalties of Domino's franchises and intellectual property assets. This investment is a positive indicator for investors. While it may not seem bullish because Domino's will be paying a nominal rate of 5.25%, this investment shows strength.
Guggenheim stated the thought process behind the investment is that Domino's is expanding overseas and increasing revenues and income at a rapid pace. This indicates that Domino's may be expecting higher revenue over the next few years than last stated during the March earnings report. If this is the case, which is very possible, then Domino's will be reporting strong earnings and an upwardly revised guidance come the next earnings report.
While fundamental analysis is more important when it comes to long term investment decisions, it is very useful to use technical indicators to find a strong buy level. The first indicator is the 10 and 20 day SMAs. The 10 and 20 day SMAs are more of short term indicator as to how the stock will perform. Currently the 10 day sits 66 cents below the 20 day SMA. When these two cross we should see the stock begin to move higher. We saw the peak distance between the 10 and 20 day SMA seven days after the initial cross on March 26th. Currently we are nine days since the peak divergence level. If the stock flat lines the next few days we will see these two SMAs make a short term bullish cross within three trading days. This indicates that Domino's stock at 35 is a terrific buying opportunity.
Chart courtesy of Yahoo.com.
The next indicator is the RSI. The RSI is, as its name presents, relative. Every stock will have a different RSI. There is no rule of thumb when it comes to analyzing the RSI. But what is important is watching the long term RSI trends. By doing this you can determine when the stock is at a short term bottom and top. Over the past 12 months Domino's stock has seen the 40 level as a buy sign. Every time the stock dips below 40 the stock immediately moves higher. However after the special dividend this trend was broken. The stock stayed below 40 for about 12 trading days before coming back up on April 12th. This is an indication that Domino's stock is ripe and ready for the picking because the RSI is at historically low levels.
The final technical indicator is the old fashioned 20,2 BB. The BB is an indicator that suggests when a stock is oversold and overbought. In theory when the stock hits the upper limit it is overbought, and when the stock price hits the lower limit it is oversold. A stock price sitting directly in the middle indicates that it is balanced. Currently Domino's stock sits towards the bottom end of the BB. It is not oversold per se, but the stock is leaning towards an oversold position.
Chart courtesy of Yahoo.com.
All three indicators paint the same picture. They suggest that Domino's stock is a short-term buying opportunity. The BB and RSI suggest that Domino's stock is currently on the weak (oversold) side of the coin, and the near-term SMAs are indicating that the stock is ready for a surge upward.
How high will the stock move? That will depend on the May earnings release. Under a strong earnings report and continued bullish market Domino's stock will easily eclipse the current 52 week high of 42.21 by mid May. This would account for a 20% appreciation in the stock price over a four week period.
Domino's stock appears to be finishing up a standard retracement. I would not be surprised to see the stock dip below the 35 level before shooting back above. There is also the possibility that Domino's continues to move lower. I am not expecting this to happen because the firm's operating cash flows are improving, and long term fundamental investors will pick up the stock if it continues to depreciate. Also, Domino's stock has yet to move anywhere close to the $3 reduction per NYSE rules regarding dividends. This has been the main detractor for the stock. If not for the dividend the stock would be trading at 38, assuming all else equal.
In the end it appears Domino's stock should be heading higher in the near term. When the current retracement seizes, which will likely be within the next week, the stock will continue the rally we have seen the past two years, which in review, matches Apple stride for stride.
Disclosure: I am long DPZ.