Restaurant Stock to Buy the Dip

Warren Buffett, Joel Greenblatt, and Charlie Munger are some of the most successful investors of all time, and much of their fortunes have been amassed by buying great businesses when they’re on the sale rack.

The tricky part about this strategy is that these high-quality companies rarely show up on traditional value lists from a screening standpoint, given that most value investors are screening for only stocks trading at single-digit PE ratios.

In the case of the highest-quality growth stocks with phenomenal track records, it is very rare to see them drop into single-digit PE territory, and it’s even rarer to see them stay there long enough for screens to spit them out as buy-the-dip candidates.

So, investors looking to emulate the success of famous value investors must constantly track these companies during periods of market weakness and focus more on their discount to their historical multiple, not their discount vs. peers that are inferior to them.

While the 28% correction in the S&P-500 (SPY) has yet to yield many so-called “fat pitches”, which are extreme value disconnects, some opportunities have arisen, with a few coming from the restaurant sector.

The reason? The sector has had an unprecedented tricky two years, dealing with labor tightness and wage inflation, rising commodity costs, reduced traffic due to COVID-19 anxiety, and now a weaker average consumer.

However, with the labor situation improving, commodities potentially peaking, and dining rooms returning to normal, I believe it’s time to be cautiously optimistic, and one name is trading at levels where buying the dip makes sense.

A High-Quality Franchisor At An Attractive Price

Domino’s Pizza (DPZ) is an $11.4 billion pizza company with ~19,500 restaurants globally and a very attractive 98% franchised model, making it relatively inflation-resistant.

This positioning as a franchisor has allowed the company to outperform from a margin standpoint vs. operators in the restaurant space like Brinker (EAT), BJ’s Restaurants (BJRI), and others, given that it’s been relatively shielded from commodity and wage inflation, except at its company-owned restaurants (2% of system).

However, the stock has fallen out of favor over the past year, tumbling 43% from its highs and shedding $9.0 billion in market cap.

The reason? Delivery challenges and softer sales.

From a delivery standpoint, Domino’s noted on its recent calls that it was having difficulty securing an adequate number of delivery drivers, prompting the company to actually pay you to pick up your pizza order earlier this year.

The initiative was called carry-out tips, and customers revere receiving a $3.00 tip to act as their own delivery driver and pick up their pizza.

While this provided some help during the labor shortages, the other issue was that Domino’s was lapping tough comparisons relative to the record year for the pizza industry in 2020.

This is because, after a year of eating pizza due to not being able to dine out, we’ve seen a little bit of a hangover with consumers getting used to their usual routine, which was not regular pizzas but a wider array of dining options.

Fortunately, Domino’s has lapped these difficult comps and is back to steady sales growth, reporting 7% growth in Q3 with revenue of $1.07BB (Q3 2021: $998MM).

The good news for investors is that this growth story has been ignored among this negativity (higher cheese prices, tighter labor, difficult sales comparisons), and Domino’s continues to be a phenomenal growth story despite its scale.

In fact, the company expects to continue growing its restaurant base at 4% per year, an impressive figure relative to the larger restaurant names globally like McDonald’s (MCD).

This should allow the company to grow annual earnings per share from $13.60 in FY2021 to $17.70 in FY2025, a respectable figure (6.8% CAGR) for a large-cap company in a recessionary environment.

The Fundamental Case

From a valuation standpoint, DPZ has historically traded at 33x earnings (10-year average), a premium to its peer group due to its strong positioning in all economic environments and incredible growth.

The former is related to the fact that pizza carries a relatively low average check when it comes to feeding a family, meaning that while consumers drop some casual dining visits, they might actually increase their pizza ordering incidences.

Due to negative sentiment toward the restaurant industry, DPZ trades at just 22.8x FY2023 earnings estimates ($14.16) today, a massive discount to its historical multiple, and a very attractive valuation for a high-quality and low-risk business model (recession-resistant and inflation-resistant).

The Technical Picture

Regarding the technical picture, DPZ remains below all of its key moving averages, which is a negative, but there have recently been green shoots.

Not only did the stock jump 10% after its Q3 results despite not beating estimates which suggests that a lot of negativity is priced in already, but it saw its highest weekly volume in over two years with the $300.00 level successfully defended again.

See the Full Technical Analysis Report for DPZ

Since then, the stock is working on its fourth consecutive weekly gain, a significant change of character from a sea of red since Q4 2021.

While a stock not going down any further doesn’t mean it has bottomed, the consistently higher lows the past few weeks while the market made new lows suggests that DPZ may be in for a medium-term rally (and has potentially bottomed out long-term).

So, if we can see a better earnings season that could push the S&P-500 back above the 3900 level, I would not be surprised if this marked the low for DPZ for the next several months. Hence, buying on any intra-week weakness for DPZ is likely a solid strategy.

The Bottom Line

Based on what I believe to be a fair earnings multiple for DPZ of 30.0 (10% discount to historical multiple) and FY2023 annual EPS estimates of $14.16, I see a fair value for the stock of $424.80.

This points to a 33% upside, and investors are also getting a 1.50% dividend yield to wait for a turnaround, similar to the S&P-500’s yield.

So, for investors looking to diversify their portfolios and add a high-quality name trading at a deep discount to fair value, I see DPZ as a Buy on weakness.

The above analysis of Domino’s Pizza (DPZ) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Is Domino’s Pizza (DPZ) A Buy or Sell?

Based on MarketClub’s technical analysis tools, Domino’s Pizza (DPZ) is moving in a sideways pattern and is unable to gain momentum in either direction. Beware of choppy movement and consider a sidelines position until a stronger trend is identified.

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