Domino’s Pizza ($DPZ) is a popular pizza restaurant that serves about 1.5M pizzas daily from about 11,600 store units across 75 countries. The company is set to report 2015 Q3 earnings on Oct. 8th. So far this year, the shares of Domino’s Pizza has well outperformed the S&P 500. The stock is up around 10% YTD while the S&P 500 has a negative percentage return YTD.
A Look at the Numbers
Revenue and Macro Impact
Restaurant Sales and the Unemployment rate is strongly correlated. When the unemployment rate is high, fewer people spend money at fast-food chains and other restaurants. Conversely, as we’ve recently seen the unemployment rate sinking lower we could potentially expect better Net Sales results from the restaurant industry as a whole. However, while we are approaching full employment levels, wage inflation is still low. This could make people more careful with their dollars and choose lower cost food alternatives, like Domino’s Pizza, vs. pricier options.
The Revenue results at Domino’s Pizza is highly driven by same-store sales growth, a metric the company has been historically successful in increasing. The analyst revenue target for Q3 2015 is $486 million, an increase of ~9% year-over-year.
From a relative valuation perspective, $DPZ appears undervalued at its current price level of around $105 compared to its peers. Below you can see a relative valuation using $MCD, $PZZA, $SBUX and $YUM as comparables. If we look at the operating multiple EV/Revenue, $DPZ’s multiple of 3.46 is lower than $MCD and $SBUX. As for the EV/Ebitda, $DPZ is also relatively low. The multiple of 19.7 is lower than all selected industry peers except for $MCD. $MCD is also the only company in this relative valuation that has a lower PE ratio than $DPZ’s PE of 33.
Source: SprinkleBit Analyzer
Now, considering the relatively low fundamental metrics of $DPZ, you could guess that the company is having a slow Sales Growth which would make investors value the shares lower. That is not the case though, $DPZ also has a significantly higher Sales Growth Percent (8.47%) than most of its peers. Both $YUM and $PZZA (the restaurant company who owns Pizza Hut) has negative sales growths. Only $PZZA has a slightly higher percentage number (9.7%). But, keep in mind, investors are already paying more for the EPS growth of $PZZA then they are for $DPZ. The PEG ratios of $DPZ and $PZZA are 1.72 and 3.02 respectively.
Even though the current price point is undervalued at the company’s fundamental metrics, it can change significantly with the Q3 earnings report next week. Analysts will pay extra attention to the company’s ability to generate same-store sales growth. In a recent business update, Domino’s stated that the domestic sales growth increased to 10.5% in the Q3 -2015. This is in line with analysts expectation of around 10%. Next, another key number will be the Operating Income, which is expected to come in at $86.5M. This is 9.5% higher than the Operating Income in the same quarter last year. The EBITDA (earnings before interest, taxes, depreciation and amortization) is expected at $93.5M. The current EBITDA margin is 17.6%. Which is already high for the industry but the analyst consensus expectations is a margin of over 19%.
Operating Cash Flow
Domino’s weakness seems to be the ability to generate cash flows from revenues. Compared to its industry peers, the company’s Operating Cash Flow-to-Sales ratio of 11.3% is lower than all comparables except for Papa John’s. Therefore, the Operating Cash Flows will also be an important number to keep your eyes on at the upcoming Q3 earnings release. If the company can improve the OCF ratio, it will prove that its current business structure is positive and that the company is heading in the right direction.
The general consensus expectation is EPS of 0.74, which is a 17% increase from the same quarter last year. $DPZ has beaten analyst EPS expectations in 3 out of the last 4 quarters. Yet, the market reacted negatively to the earnings report in the last quarter and the stock price dipped lower during three days following the earnings release.
What can we expect in Q4?
The common recent topic for global U.S. based firms has been the negative effect a strong dollar has had on its sales. About 93% of Domino’s Pizza’s revenue comes from the United States so the impact of currency headwinds should not severely impact the company’s sales. From the recent business update released by Domino’s, we find out that both domestic and international sales growth is higher in Q3 2015, 10.5% and 7.1% respectively, than for the same quarter a year ago. If the company reports healthy operating cash and income margins and growing bottom-line results for this third quarter of 2015, the stock has a continuous upside potential of 10-14% throughout the fourth quarter of this year.
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