Image Source: Domino’s Pizza Inc – Second Quarter of Fiscal 2021 IR Earnings Presentation
By Callum Turcan
One of our favorite capital appreciation ideas is Domino’s Pizza Inc (DPZ), and we include shares of DPZ as an idea in our Best Ideas Newsletter portfolio. The company’s unit economics are incredibly attractive for current and potential franchisees, which encourages current franchises to expand their existing operations and potential franchisees to join the team. At the top end of our fair value estimate range, Domino’s Pizza has a fair value of $541 per share, well above where shares of DPZ are trading at as of this writing.
Great Business Model
Domino’s Pizza recently launched its first store in Lithuania and now operates in over 90 markets around the globe. At the end of its second quarter of fiscal 2021 (period ended June 20, 2021), Domino’s Pizza had over 18,050 store locations worldwide with over 880 net store locations added to its operations during the four fiscal quarters ended June 20, 2021. Roughly 98% of those locations are franchised as Domino’s Pizza strives to have an asset-light balance sheet.
As one can see in the graphic at the top of this article, Domino’s Pizza sees ample room to further expand its store base over the coming fiscal years. That includes 1,500+ potential unit store growth opportunities in the US and 6,500+ potential unit store growth opportunities across its 15 major international markets. This vast growth runway underpins our expectations that Domino’s Pizza will be able to steadily grow its free cash flows at a robust pace over the coming fiscal years.
We are enormous fans of its business model as it enables the company to generate sizable free cash flows in almost any operating environment due to its relatively modest capital expenditure requirements to maintain a given level of revenues. For instance, during the first half of fiscal 2021, Domino’s Pizza generated $262 million in free cash flows and had a free cash flow conversion ratio (free cash flow divided by GAAP net income) of 112% during this period. In fiscal 2020 (period ended January 3, 2021), Domino’s Pizza generated $504 million in free cash flow and had a free cash flow conversion ratio of 103%. The company’s run-rate dividend obligations stood at $122 million in fiscal 2020.
Please note that while Domino’s Pizza exited the second quarter of fiscal 2021 with a net debt load of $4.8 billion (exclusive of restricted cash, inclusive of short-term debt), we view that burden as manageable given its stellar free cash flow profile. In the medium term, Domino’s Pizza forecasts that its same-store sales growth performance will continue to come in strong as one can see in the upcoming graphic down below, aided by its stellar home delivery (fast, dependable) and digital (easy to use, engaging user interface, integrated with popular loyalty programs) operations.
Image Source: Domino’s Pizza views its same-store growth outlook over the medium-term quite favorably. Image Source: Domino’s Pizza – Second Quarter of Fiscal 2021 IR Earnings Presentation
For reference, during the second quarter of fiscal 2021, Domino’s Pizza’s US same-store sales grew 3.5% year-over-year and its international same-store sales grew by 13.9% year-over-year. Domino’s Pizza noted in its fiscal second quarter earnings press release that the fiscal “second quarter marked the 110th consecutive quarter of international same store sales growth and the 41st consecutive quarter of U.S. same store sales growth” which is simply stunning. Again, we will stress that this is the kind of performance that encourages franchisees to join forces with Domino’s Pizza. Few if any quick-service restaurants, fast-food joints, and other pizza chains can boast about such performance.
On a final note, Domino’s Pizza did a stellar job navigating the many hurdles created by the coronavirus (‘COVID-19’) pandemic, though inflationary pressures and labor headwinds seen of late represent new obstacles. During the company’s second quarter of fiscal 2021 earnings call, management had this to say in response to a question from an analyst about pricing initiatives and rising labor cost concerns (emphasis added):
“To the first part of your question, most certainly when we look at the labor and the wage environment, wages are only going in one direction over time and that is up. Some of that obviously is dictated by some of the minimum wage changes that are happening, another round of which occurred in here in July. But also just the general supply and demand equation in the labor market is causing wages to go up. And we’re certainly continue to invest more in our hourly team members in our corporate store business to make sure that we can remain staffed and serve our customers.
When we think about how do we offset those wage increases and still deliver a terrific four-wall economic model? Pricing is certainly one of the levers that is out there. And at the local level we do this in our corporate stores. And our franchisees have — they have the latitude to do this for their businesses. We have taken some increases in our single transparent delivery fee. We charge — wherever we are we charge a single fee.
It varies significantly market-to-market based on the local dynamics. But that’s certainly a lever that we and our franchisees have pulled. And then menu pricing, our franchisees have control of that. And in the higher wage markets you will find higher menu prices — generally higher menu prices at Domino’s.” — Richard Allison, CEO of Domino’s Pizza
Domino’s Pizza is being realistic as it concerns labor expense pressures, which are a perennial part of the business (especially in countries with aging demographics such as the US, Japan, China, and large parts of Europe). In our view, Domino’s Pizza is well-positioned to navigate these headwinds going forward, and the firm is laser-focused on optimizing its pricing schemes. We expect that Domino’s Pizza will continue to fire on all cylinders going forward.
Concluding Thoughts
Domino’s Pizza is one of the best in the business. Though global equity markets are experiencing significant volatility of late–and please note that we added some put option “protection” to our newsletter portfolios as a result on October 4 (more on that here)–we continue to view Domino’s Pizza’s capital appreciation upside potential quite favorably. Shares of DPZ yield a modest ~0.8% as of this writing, and we forecast that Domino’s Pizza will grow its payout at a robust pace going forward, offering incremental income generation upside to its capital appreciation potential.
Domino’s Pizza 16-page Stock Report >>
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Callum Turcan does not own shares in any of the securities mentioned above. Chipotle Mexican Grill Inc (CMG), Dollar General Corporation (DG), Domino’s Pizza Inc (DPZ) and The Walt Disney Company (DIS) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Dick’s Sporting Goods Inc (DKS) and Home Depot Inc (HD) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Long put options on the
SPDR S&P 500 ETF Trust (SPY) with an expiration date of December 31, 2021, and strike price of $412 are included in both the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.