Investors holding Domino’s Pizza (NYSE: DPZ) shares thought they truly held a stock with uncapped growth potential in early February. Shares of the pizza giant were trading as high as $294.86 on February 11th but have since declined to a fresh monthly low of $248.57. The most evident reason behind this was the company’s weaker than expected earnings that underperformed most analyst’s estimates. The market's overreaction to this news has presented an opportunity for investors to swoop in and buy this stock; shares will be back in the $280 to $300 range by year-end 2019.
Q4 2018 results indicated:
- $1.08 billion in revenue (below avg. analyst estimate of $1.10 billion).
- $2.62 EPS (below avg. analyst estimate of $2.69 EPS).
- Quarterly same-store sales growth in the US of 5.6% (below avg. analyst estimate of 7.2%).
- Quarterly same-store sales growth of 2.4% internationally (below avg. analyst estimate of 4.2%).
At first glance, missing Wall Street expectations of same-store sales growth both internationally and in the United States does seem troubling for the world’s leading pizza company. However, the company still posted solid growth in both regions and simply illustrated a case of a slightly overvalued stock.
Source: Yahoo Finance
Cash flow from the company's operating activities totaled $394.2 million at year-end 2018 while cash and cash equivalents stood at $25.4 million, lower than $35.8 million a year prior. The company's long-term debt was reported at 3,495.7 million, an increase compared to $3,121.5 million in 2017. Although the decrease in cash and increase in long-term debt may trouble some investors, revenue and earnings are still healthily growing while Domino's continues to ramp up capital expenditures which were reported at $119.9 million.
Prior to Q4 2018, the previous three quarters showed Domino’s Pizza beating Wall Street estimates by an average of 9.85%. Missing earnings by 2.6% in Q4 2018 spooked investors into believing that this stock may have reached a saturation point in the market with limited potential for further growth. However, on a yearly basis, the company has been able to keep earnings growth fairly in line with revenue, a positive sign for investors. Relatively high expectations of Domino’s have temporarily battered the company, but they are poised for an up-rise.
In a statement, Domino’s CEO Ritch Allison stated, “I am pleased with our fourth quarter, which capped a very strong 2018 for Domino’s, our long-approach, driven by fundamentals and the finest franchisee base in QSR across the globe, continues to pace the industry – and we are excited to execute our global strategy in 2019 and beyond.” The fundamentals are indeed one of the strengths of this company, and a growing franchisee base adds to an array of growth potential opportunities the company will further exploit in 2019 and onward.
Building Upon Competitive Advantage
Domino’s is a leader not only among its pizza competitors, but in the restaurant industry as a whole. The company boasts capabilities that very few companies can integrate given the capital considerations in a market characterized by fierce competition for market share. Domino’s has been the first mover in many categories, and the strategy has paid off large dividends.
At the forefront of any successful company is rapid innovation in both current and emerging trends. In 2015, Domino’s launched a fleet of customized pizza-delivery vehicles. These vehicles were in partnership with Chevrolet (NYSE: GM) and featured a warming oven and extra storage seats capable of holding up to 80 pizzas at a time. In 2016, the first ever pizza was delivered by drone as Domino’s began considering partnerships with drone delivery service organizations and eventually integrating these processes and technologies into their own company’s model.
In 2018, Domino’s increased the stakes after releasing a viral video in partnership with Ford (NYSE: F) portraying a self-driving delivery vehicle delivering pizza to a customer. Drone delivery, robot delivery, autonomous vehicle delivery are just a few public examples of the company’s innovations; one can only imagine what the R&D team is doing to top all of this. Overall, it’s amazing that something as simple as a pizza chain can be perceived by the public as a futuristic innovative company.
As a millennial, I can also tell you that Domino’s dominates the world of social media. Not just through viral videos such as those mentioned above, but through a savvy approach in digital marketing that appeals to consumers looking to join in on what everyone else is viewing. The company has gone as far as launching games including “Pie in the Sky Pursuit” where players compete for a chance to win free prizes. The company is actively involved with their Facebook, Twitter, and Instagram profiles, consistently encouraging users to participate in various discussions. With a large and growing social media presence, how convenient is it that Domino’s customers can order through websites and apps such as Twitter and Facebook?
Stephen Dutton, an analyst at Euromonitor International may have said it best, “Delivery is what the consumer wants. And Domino’s does it best, when you’re sitting at home watching Netflix, you’re going to think of Domino’s.”
In the restaurant industry, delivery is at the core of attracting new customers, maintaining existing customers, and increasing revenue from existing customers. Other restaurant competitors such as Pizza Hut (NYSE: YUM), Papa John’s Pizza (NASDAQ: PZZA), McDonald’s (NYSE: MCD), and Chipotle (NYSE: CMG) still rely on desktop ordering for the majority of sales and are in only the early stages of building upon mobile orders. On the other hand, Domino’s gives customers options for delivery.
With a variety of options extending further than just plain desktop and mobile ordering, Domino’s allows customers to order through iOS and Android compatible devices such as Google home, Amazon Alexa, Fitbit, SMS, Facebook Messenger, Twitter, Ford Sync, Slack, Apple Watch, Android Wear, Samsung Smart TV, and Pebble. These leading-edge capabilities only translate to more sales, and will only to continue generating sales as these technologies individually develop.
Domino’s innovative strategy has also expanded to its supply chain management. Using Talend (NASDAQ: TLND), a cloud data integration leader, the company has utilized big data to construct infrastructure that processes information for supply chain centers, point-of-sales systems, and social media platforms. This data is eventually funneled into Domino’s Enterprise Management Framework, where it is used in tandem with other data including geocode, competitive, and demographic information from third party sources including the United States Postal Service.
Domino’s custom operating system has proved to be rather lucrative given more than 60% of the pizza chain’s sales are derived from Domino’s digital channels. Franchisees benefit from lower transaction costs while Domino’s gathers consumer intelligence, a triple-win for the franchise, Domino’s, and consumers who are offered better service and products.
Using this technology, Domino’s has been able to provide cheaper food than Little Caesars, Pizza Hut, and Papa John’s, ultimately leading them to a leading position in market share with upwards of 17% in the quick-service pizza business. Internally, employee engagement is at an all-time high with Domino’s standing by and reinforcing a mantra that provides incentives and shows employees how they could one day own their own franchise.
Indeed, franchisees are in control and own more than 90% of the 15,000 Domino’s pizza restaurants worldwide. This number has only continued to increase as profit-sharing arrangements improve under a business model consisting of earning revenue through selling franchises store ingredients, equipment, and collecting franchise fees. Stifel analyst Chris O’Cull notes the development as a “competitive advantage” for the pizza giant.
Of course, with any new technology, the company faces the risk that investments don't turn out to be as lucrative as predicted. The increase in long-term debt must also be closely monitored to ensure that Domino's doesn't leverage its spending habits to a point that would negatively pressure the company in the event of external shocks. Finally, although the company has vast ambitions to conquer high-growth international markets, sales in the United States still make up a relatively large portion of the company's earnings and can't be overlooked, winning the American customer will still be highly important.
The company trades above the US market average P/E ratio of 17.5 with a P/E of 31 and uses a moderate level of debt to finance their investment and operations. This solidifies that investors have high expectations of the company and explains the most recent moderate sell-off of the company’s shares. Domino’s success in attracting younger customers neglected by its competitors and cutting costs to provide cheaper food without sacrificing quality attracts the younger cohort that constitutes the majority of the pizza giant's sales.
Additionally, the company's franchisee-focused approach and first-mover advantage in building upon digital innovation that embraces current and emerging trends, ultimately points towards a business model characterized by numerous competitive advantages that will only continue to win market share from competitors and build upon its No.1 ranking in global retail sales. Buy Domino's shares at the $240 level and enjoy a bountiful return as its exceptional business model continues to drive growth to the $280 to $300 by year-end 2019.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.