Could Domino's Pizza Be a Millionaire-Maker Stock?
By Nicholas Rossolillo – Oct 14, 2020 at 7:55AM
NYSE: DPZ
If ever there was a restaurant chain built for COVID-19, this is it.
Domino's Pizza (DPZ -0.70%) continues to demonstrate its ability to thrive during the pandemic. The global pizza franchisor posted 21.3% sales growth in the U.S. and 7.7% sales growth internationally during the fiscal third quarter of 2020, helped by social distancing which kept more people eating at home and ordering out.
Though it's already one of the largest chains in the world with more than 17,000 locations worldwide at the start of September, this restaurant with deep roots in delivery and technology was built for the new digital era that is dawning. But don't expect it to get you to millionaire-status all on its own.
Enduring growth: before, during, and after the pandemic
For the last few years, Domino's has embarked on a growth strategy it calls "fortressing" in which new locations are opened in existing markets to get stores progressively closer to consumers. While fortressing may cannibalize sales at existing locations, more restaurants means shorter delivery times and a quicker drive for those diners who favor pick-up. Management has long believed that increased convenience will lead to long-term growth.
Leading up to the pandemic, the strategy was working. Domino's comparable-store sales growth (or "comps") remained in positive territory even as the restaurant industry overall stagnated. And it turns out fortressing was fortuitous given the current state of affairs. In the fiscal second-quarter (the three months ended June 14, 2020), U.S. comps surged 16.1% year over year and international 1.3%. The winning streak continued in the latest quarter (the three months ended Sept. 6, 2020) with U.S. comps rising 17.5% and international comps up 6.2% from a year ago. The global restaurant industry has been in decline since the spring, so Domino's focus on delivery is serving it well and helping it scoop up industry market share.
Profit margins have also improved. Through the first nine months of 2020, Domino's has generated a net income margin of 12.3% on revenue of $2.76 billion -- compared to an 11.0% margin on sales of $2.47 billion in 2019. Free cash flow (revenue minus cash operating and capital expenses) is similarly on the rise, up 13% so far this year to $319 million. For the highly competitive food service industry, even low single-digit percentage margins are an enviable result, with or without COVID-19.
A rich valuation but for good reason
Lots of restaurant stocks traded at a steep premium headed into the pandemic, even though their growth was lackluster and profit margins thin. In hindsight, Domino's looks like one of the few that deserved a premium price tag, given that delivery services are in such high demand right now. And with digital and delivery likely to be an enduring consumer must-have going forward, Domino's stock trading for a whopping 36 times trailing 12-month earnings is at least partially justified -- although it's a little rich for my taste at the moment.
However, I wouldn't fault investors for picking Domino's stock over other restaurant chains that are attempting a recovery. Domino's needs no such rebound as it was built for crises like the current one, and its investments in technology to make online ordering a cinch and enable flexible order fulfillment options have built an enduring growth story.
For those investors who also want in on autonomous vehicle and logistics development, this restaurant stock yields some exposure there too. It has signed partnerships over the years to develop the tech, like a pilot program in Houston, Texas with autonomous delivery start-up Nuro over the summer of 2019. Domino's supply chain fees (related to delivery services) were $1.63 billion so far in 2020 -- nearly 60% of total revenue -- making advancements in delivery and logistics another possible growth driver for the pizza chain in the years ahead.
Nevertheless, with a market cap of $16 billion as of this writing, Domino's is already one of the largest restaurant businesses in the world. And cash and equivalents of $331 million and total debt of $4.1 billion reflect that this is already a mature business. All by itself, I don't think Domino's Pizza will be a millionaire-maker bet. But as part of an investment motif focused on a more digital future, this is one of the better restaurant stocks around.
Nicholas Rossolillo has no position in any of the stocks mentioned. The Motley Fool recommends Domino's Pizza. The Motley Fool has a disclosure policy.
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