It’s been a tough 14-month stretch for the major market averages.
While investors focused on great businesses trading at deep discounts to fair value have managed to outperform the indexes, it hasn’t been easy and many former leaders have been taken out and shot.
With the S&P 500 (SPY) now up ~15% off its lows, many of the extreme value opportunities have been snatched up, especially among large-caps, but one name has recently dropped onto the sale rack for the first time in nearly a decade.
The catalyst for the stock’s decline and move onto the sale rack was a disappointing Q4 report with sales coming in light at $1.39 billion (estimates: $1.44 billion), and US same-store sales barely positive at 0.9% for the quarter and in negative territory on a full-year basis.
These same-store sales results paled in comparison to the quick-service restaurant average and were somewhat alarming given that the company has historically seen higher demand for its offerings during recessions with consumers looking to trade down and save money.
An Attractive Valuation For This Long-Term Compounder
Domino’s Pizza Inc (DPZ) is a $10.5 billion pizza franchisor in the restaurant sector with ~19,800 locations across 90 markets and a business model where 99% of stores are owned and operated by franchisees.
This model has allowed the company to mostly sidestep the inflationary pressures that have weighed on the earnings growth of restaurant operators over the past few years, and its steady unit growth which clocked in at ~6% last year (1,032 net new stores) has helped it to maintain a market-leading earnings growth rate.
In fact, annual EPS has climbed from $1.69 in FY2011 to $13.60 in FY2021, but did slip in FY2022 to $12.53, its first annual decline in over a decade.
From a franchisee profitability standpoint, Domino’s noted that average US franchise store EBITDA came in near $137,000 in 2022, only down slightly from $143,000 in 2019, leading the company to believe it has room to grow to 8,000+ stores in the US alone (~6,700 currently).
Unfortunately, the company did note that the macroeconomic headwinds have affected the US delivery business with some consumers choosing to eat at home vs. take-out due to tighter budgets.
Domino’s updated its three year outlook, with global net unit growth guided down to 5-7% from 6-8% previously.
Not surprisingly, this weaker outlook and continued headwinds weighed on the stock, and while there was some excitement about its new Loaded Tots in time for its largest sales day of the year, the SuperBowl, the soft Q4/FY2022 earnings have investors nervous.
The result is that DPZ is one of the worst-performing large-cap names year-to-date, down 15% vs. a ~4% gain for the S&P 500.
However, I believe the time to buy great businesses is when they’re on sale and out of favor, and there’s no question that Domino’s is out of favor after multiple downgrades and a 48% share-price decline.
Plus, I don’t see any change to the long-term thesis here even if the company’s sales performance was a little weaker than I expected given that I anticipated some tailwinds from trading down in the US and globally.
The Fundamental Case
Domino’s Pizza has consistently traded at a premium multiple relative to its quick-service restaurant peers, with a 5-year average earnings multiple of 33.3, a 10-year average earnings multiple of 32.0, and a 15-year average earnings multiple of 29.4.
These figures are more than 15% above that of larger-cap peers that have traded at multiples of 22-29x earnings, with Domino’s premium multiple tied to its industry-leading unit growth and solid execution, especially under its previous CEO, Patrick Doyle (2010-2018).
Although Domino’s maintained this premium multiple post-pandemic especially as we saw increased demand for pizza as take-out options were limited, the stock has since seen its forward PE ratio plunge from a peak of ~43.0 to just ~22.9, with this being tied mostly to the 48% decline in the stock.
To be fair, the stock was significantly overvalued at its December 2021 peak, but after this sharp decline, the stock has overshot to the downside by a wide margin.
So, although there was no previous case for owning Domino’s while it traded above $400.00 per share (and briefly as high as $567.50), the case for owning Domino’s now is arguably the most attractive since 2015 when it last traded at below 20x forward earnings.
The Technical Picture
Traders with a trend-following strategy would not touch Domino’s with a ten-foot pole here, with the stock hitting new multi-year lows this week and taking out its October 2022 lows on a daily closing basis.
Meanwhile, the stock is below all of its key short-term moving averages and its 200-day moving average will take on a negative slope if the stock can’t put together a strong rally immediately.
However, from a bigger picture standpoint, Domino’s is resting on its 80-month moving average, a level it hasn’t tested since June 2010 when it endured a similar ~40% correction.
While there’s no guarantee that the stock will find strong support here, this has typically been an area to be open-minded to starting new positions in large-cap names with strong business models.
And, Domino’s business model is about as strong as it gets with consistently rising operating margins, an iconic brand, and strong profitability among franchisees that should allow for consistent ~5% unit growth over the next several years.
So, with expectations low, the stock starting to become oversold, and the overall market having a tailwind in the form of a January breadth thrust, I would not be surprised to see a favorable reaction to the company’s Q1 earnings report in April.
The Bottom Line
Based on what I believe to be a fair multiple of 28.0x earnings and FY2024 annual EPS estimates of $14.90, I see a fair value for Domino’s of $417.20.
I would argue this value to be conservative given that I have used an earnings multiple that is 12% below its 10-year average to adjust for the recent loss in confidence due to the softer outlook and the multiple compression we’ve seen sector-wide related to higher rates.
Using this fair value estimate, I see a 41% upside for Domino’s to its 18-month price target, or a 45% total return when including its ~1.70% dividend yield.
Hence, I see this violent pullback below $298.00 as a low-risk area to start a position in the stock.
Disclosure: I am long DPZ
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.
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