Domino's Pizza (DPZ), the second largest pizza chain in the U.S., beat revenue and EPS estimates for Q32012. The company's shares were up 7.6% in trading yesterday, reaching $41. Though the shares are not as cheap after this appreciation, we still see an upside potential of around 10% based on the expected earnings growth. Investors can benefit from the company's repurchase program as well as international growth.
The company posted EPS of $0.43 on the back of revenues of $378 million. Analysts were expecting $0.41 with revenues of $374 million. This compares with $0.35 in Q3 2011 and sales of $376 million. Thus, the EPS was up 23% YoY based on the sales growth, the increase in number of stores, higher domestic store margins, and lower number of shares outstanding due to share repurchases over the last four quarters, though it was partially offset by the unfavorable currency exchange rate.
Same store sales were up 3.3% in the U.S. and 5% in international operations. In Q32011, same store sales were 3% from the U.S. and 8.1% internationally. The company owns its own stores as well as franchises. The same store sales of franchises in the U.S. were 3.6% better than the company-owned stores' 0.5%. The company-owned store revenues were lower because of several stores being shut down in 2011. The company opened 121 stores internationally in Q3 with franchises reaching the 10,000 stores milestone.
The board approved its third repurchase program in Q22012, amounting to $200 million. Margin expansion has taken place. Gross margins were 29.5% this quarter as compared to 27.5% a year ago. Operating margins are 16.3% as compared to 14.9% in Q32011. Similarly, net margin was 6.9% as compared to 5.9% a year ago. The 5-year average gross, operating and net margins, according to Reuters, are 27%, 14.18% and 4.86%, respectively.
The company has low debt. Total debt was $1.57 billion as of September 9, 2012. The interest coverage ratio is low but safe at 2.6. With $34 million in cash and equivalents, $87 million of free cash flows and $60.3 million of borrowings available, the debt does not seem to be a grave issue, though we would like to see an improvement in the free cash flows.
Citigroup (C) reiterated its neutral rating for DPZ with the price target raised from $37 to $45, saying that the stock seems to be fairly valued at present, but strong long-term operating performance is expected. DPZ also has the ability to innovate, efficiently market and witness international growth.
DPZ trades at a forward P/E of 18x. DPZ's primary competitors are the Pizza Hut chain (owned by Yum Brands (YUM)) and Papa John's International (PZZA), which trade at forward P/E multiples of 19x and 18x, respectively. The PEG ratios are almost the same for all three i.e. roughly 1.6.
The stock is trading at almost its 52-week high of $42. Below is the valuation for DPZ based on its EPS estimates and its forward P/E multiple, as well as at Yum's forward P/E multiple:
*2014 EPS is calculated by applying 12% next 5 year growth rate for DPZ to 2013 consensus EPS.
We recommend buying DPZ, though it is not cheap given the recent appreciation, owing to its improvement in margins, as well as domestic franchises and international business. There is still some room for appreciation (around 10% upside considering price of $45) because of international growth and share repurchases.