Image Shown: In the wake of Domino’s Pizza Inc’s stellar fiscal second quarter earnings report published on July 22, shares of DPZ surged higher. We include Domino’s Pizza as an idea in the Best Ideas Newsletter portfolio and continue to be huge fans of the name.
By Callum Turcan
On July 22, Domino’s Pizza Inc (DPZ) reported second quarter earnings for fiscal 2021 (period ended June 20, 2021) that smashed past consensus top- and bottom-line estimates with its US same-store sales growing by 3.5% and its international same-store sales increasing by 13.9%. The company noted that last fiscal quarter represented its 41st consecutive quarter of same-store sales growth in the US as its digital and delivery investments over the past decade have really paid off. Domino’s Pizza announced that it had authorized a new $1.0 billion share buyback program after the end of the fiscal second quarter after recently completing its previous $1.0 billion share repurchase program via an accelerated share repurchase (‘ASR’) agreement.
In the wake of its latest earnings report, shares of Domino’s Pizza skyrocketed higher and are currently trading above the top end of our fair value estimate range. We include shares of DPZ as an idea in the Best Ideas Newsletter portfolio and continue to be huge fans of the name. Please note that when companies move above the top end of our fair value estimate range, we do not consider removing those firms from our newsletter portfolios until after their technicals turn against them. In light of our increased future fundamental expectations of the firm, we plan to fine tune our enterprise cash flow model covering Domino’s Pizza, with the result being a fair value estimate increase.
Earnings Update
The strong unit economics of Domino’s Pizza’s stores encourages existing franchisees to expand and potential franchisees to sign up. At the end of fiscal 2020 (period ended January 3, 2021), ~98% of Domino’s Pizza’s more than 17,600 worldwide locations were franchised. In the second quarter of fiscal 2021, Domino’s Pizza added 238 net stores to its asset base including 35 net stores in the US and 203 net international stores. Same-store sales growth and a growing unit store count underpins Domino’s Pizza’s incredibly promising growth runway.
Domino’s Pizza reported that its GAAP revenues surged higher by 12% year-over-year in the fiscal second quarter with strong growth reported across the board. The company’s GAAP gross margin improved by ~70 basis points year-over-year, aided by economies of scale, while its GAAP operating margin also grew by ~70 basis points year-over-year (due primarily to its gross margin expansion). Domino’s Pizza generated $262 million in free cash flow during the first half of fiscal 2021, up 47% year-over-year. The firm spent $36 million covering its dividend obligations during this period along with over $1.0 billion buying back its stock.
Balance Sheet and Financing Considerations
We are huge fans of the company’s asset-light business model. Relatively modest capital expenditure requirements (due to its franchise-heavy business model) enable Domino’s Pizza to generate sizable free cash flows in almost any operating environment, and when things are going well, its free cash flows are well-positioned to swell higher.
Its balance sheet could be better, however. At the end of its fiscal second quarter, Domino’s Pizza had a net debt position of ~$4.7 billion (inclusive of short-term debt and long-term investments, exclusive of restricted cash and cash equivalents), which is largely the product of its past share repurchases.
The company’s cash flow profile is incredibly stable, its growth outlook is quite bright, its dividend obligations are quite modest, and Domino’s Pizza retains solid access to capital markets at attractive rates. For these reasons, we view its net debt load as manageable, though in our view, Domino’s Pizza would be wise to take its foot off the gas pedal as it concerns its share buyback strategy.
While we are big fans of Domino’s Pizza, shares of DPZ are not necessarily “cheap,” though that is not to imply that they are overvalued either, as we may be too conservative in our valuation covering the name. Improving its balance sheet over time via its “excess” free cash flows (free cash flows less its dividend obligations) would go a long way in supporting Domino’s Pizza’s long-term growth trajectory and financial health, in our view.
That being said, management is clearly taking advantage of the low interest rate environment. Here is what the firm had to say regarding its recent recapitalization strategy within its latest earnings press release:
During the second quarter of 2021, the Company completed a previously announced $1.85 billion recapitalization transaction (the “2021 Recapitalization”), including the issuance by certain of its subsidiaries of $850.0 million of 2.662% fixed rate senior secured notes with an anticipated term of 7.5 years and $1.0 billion of 3.151% fixed rate senior secured notes with an anticipated term of 10 years (collectively, the “2021 Notes”). The Company also entered into a new $200.0 million variable funding note facility, which was undrawn on the closing date, and the Company’s previous variable funding note facility was canceled.
A portion of proceeds from the 2021 Recapitalization was used to repay the remaining $291.0 million in outstanding principal under the Company’s then-outstanding 2017 five-year floating rate notes and $582.0 million in outstanding principal under the Company’s 2017 five-year fixed rate notes. The proceeds were also used to pre-fund a portion of the interest payable on the 2021 Notes and pay transaction fees and expenses.
The remaining proceeds were used for general corporate purposes, which primarily included entering into the $1.0 billion ASR Agreement, which was completed subsequent to the end of the second quarter. In connection with the ASR Agreement, the Company received and retired a total of 2,250,786 shares of its common stock at an average price of $444.29, including 2,012,596 shares of its common stock received and retired during the second quarter.
As shares of DPZ have since surged higher, its past share repurchases appear to have been a solid move, despite certain expenses incurred as part of these transactions (including the capitalization of certain debt issuance costs). We appreciate that Domino’s Pizza continues to optimize its balance sheet, though we caution that large net debt loads can hinder performance over the long run. Domino’s franchise-heavy, asset-light, and tremendous free-cash-flow generating business model can handle the somewhat elevated leverage, however.
Concluding Thoughts
Domino’s Pizza is a stellar enterprise, and we continue to like shares of DPZ as an idea in the Best Ideas Newsletter portfolio. In light of its latest blowout earnings report, we will be taking another look at our valuation model covering the name and plan to increase our fair value estimate. On top of its impressive capital appreciation potential, shares of Domino’s Pizza also yield a modest ~0.7% as of this writing and offer incremental income growth upside as well. Members interested in reading more about the holdings in our Best Ideas Newsletter portfolio are encouraged to check out our thoughts on Chipotle Mexican Grill Inc’s (CMG) latest blowout earnings report (link here).
Domino’s Pizza 16-page Stock Report >>
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Tickerized for DPZ, PZZA, PZRIF, BPZZF, WING, EATZ
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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. 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.