Domino’s Pizza: Down 45% From Highs, Pain Is Baked In (NYSE:DPZ)

We like Domino’s Pizza, Inc. (NYSE:DPZ) here at $305 for a long-term buy. This comes following its just reported quarterly earnings. We cover a range of stocks and sectors, but are very selective about the restaurant business in general because of how hit-and-miss it can be. On top of that, we are facing some extreme pressure right now.

First, inflation is rampant, and causing input costs to rise. Domino’s prides itself on providing a quality product and a very low cost, but it cannot keep its prices low and maintain its margins. Food is just too expensive. Labor costs are also high, and it has been hard to find workers in the service industry. As a stock, it has been crushed, down 45% from highs, as the market is in turmoil as a result of never-ending inflation and the Federal Reserve’s battle to take it down by raising rates.

That said, after this massive crash in the share price, Domino’s stock is much more reasonably valued, and we believe it is the type of company that is largely recession-proof. When times are tough, people still need to eat. And, if they are tough, they often eat cheaper. Cue Domino’s. Let us discuss

What to look for with Domino’s

When analyzing the business of restaurants, there are several main things we like to look for. First, we like to look to revenue to see if there are growing top-line sales. Second, we want to see controlled expenses to ensure any rise in sales generates net income growth. Third, we look for store count changes such as the closing of underperforming stores and opening of new ones in favorable locations. Finally, and most importantly, comparable sales are absolutely key.

Domino’s is delivering on most of these fronts. With the stock having been crushed, we think you can nibble at shares here at $305. Now, let us turn to the numbers.

Just reported numbers strong

In the just-reported third quarter, a trend of growth in sales continued despite the pain in markets. We are buyers here. The company, like so many others, is facing challenges and seemingly overcoming them. The company’s growth will continue long-term. The stock has seen an incredible selloff in the last year, but with football back, we think this will be a boost for pizza chains. The company is delivering strong sales results, all while controlling expenses.

In this quarter, Domino’s delivered a top line showing growth, but a slight miss on earnings due to high expenses. Let’s first address these revenues.

Sales rising

Sales were up when we back out the negative impact of foreign currency. They grew 4.7% in Q3 2022. Volumes were strong, and higher volumes are welcome news, but what about same-store sales? Well, the same-store sales increased as did store count in domestic markets, but slipped in international markets, boosting sales. Revenues came in at $1.07 billion and were in line with consensus estimates. That is strong. But how about same-store sales, which is a key indicator?

Well, we mentioned they were up. In the U.S., same-store sales grew 2.0% during the quarter versus the year-ago period. U.S. same store sales growth has occurred for most of the last 10 years. Great result. But international same-store sales fell 1.8% during the quarter. Europe was notably weak, especially in the U.K. where the economy is just bad, and a valued added tax holiday has expired. As far as store growth, factoring in closings and remodels, it had global net store growth of 225 stores in the quarter, comprised of 24 net new domestic stores and 201 net new stores outside the U.S.

Costs weigh on margins

While sales were up, we do note that the costs to generate these revenues were higher than we would like. Expense management is a key component of the company, although, in the present quarter, administrative expenses improved as the company has shifted into technological advances inside stores, but labor and input costs rose. The corporate “market basket pricing to stores” increased 13.4% during the Q3 2022 vs. Q3 2021. Margins declined and it hit income from operations. Operational income fell $3.8 million, or 2.1%, in Q3 2022 as compared to a year ago, primarily due to lower U.S. company-owned store and supply chain gross margins. These decreases were partially offset by lower general and administrative expenses.

That said, turning to income, we see that net income fell 16.5% versus last year. On a per share basis, income was $2.79 as opposed to $3.24 in the prior year quarter, falling 13.9%. While this is a decline in performance, and missed consensus by $0.24, it was mostly due to the increased inflationary expenses. But the valuation and growth metrics of the company are both getting attractive, in our opinion, although the latter has stalled for now.

The price of the stock is down so much that all the pain is largely priced in for a buy here at $305 and below. The balance sheet has some cause for concern, but we like the cash being given back to shareholders.

Domino’s Pizza balance sheet

We should point out that the company does has a debt burden of $5.15 billion. This is likely the biggest risk to be aware of when investing here. That is sizable. Right now, they have $115 million in cash, which is more than sufficient. Net cash provided by operating activities was $330 million during the three fiscal quarters of 2022. The company has spent $50 million on CAPEX. The company is repurchasing shares too, having bought back nearly half a million shares for $196 million, and continues to have $410 million remaining on the authorization. Finally, the company pays a $1.10 dividend per share quarterly, or 1.5% annually on the yield. All things considered, the stock is a buy.

Take home

Bottom line? This quarter was one that many investors were nervous about, but the company did also reduce its guidance for CAPEX spending and administrative costs, although foreign exchange will continue to weigh. But, if times are getting tough, remember that people need to eat. Pizza is cheap. Domino’s has some pricing power, but keeps its products affordable. Inflation is weighing, but we think after a 45% decline, shares are worth owning here.