Domino's Pizza: Currently Trading At An Extended Valuation (NYSE:DPZ) (2024)

My Overall Investment Thesis

Following a value-focused approach to investing, I am very conservative in my investments, only searching for great companies that I can buy at fair prices. Domino's Pizza, Inc. (NYSE:DPZ) is a growing pizzeria chain that has seen a massive stock appreciation since its IPO back in 2004. DPZ operates stores both in the United States and Internationally and has seen store growth accelerate through their franchising program. Considering the massive growth of DPZ over the last two decades, guidance about the company outlook, and the positive trend of the stock over the last year, I did a fundamental analysis to see if the stock is worth buying at this price based on the last ten years of available data. Based on the data presented in my analysis, I believe this company is modestly overvalued and may decline over the short term (12-24 months). I am giving this company a sell rating, meaning that I would not start a position at this overextended price because of a greater risk of capital loss. A short-term price decline would open up the opportunity for long-term investors to buy this otherwise great company at a fair price.

Company Outline

Domino's Pizza, Inc. is a growing restaurant chain that has been focused on innovation in their products and operations to drive growth year over year. In their recent earnings call, DPZ announced one of their largest product innovations in recent years, now offering thin crust New York style pizza. This new style of crust will appeal to customers who prefer a different style of pizza, further driving company growth. Moreover, to drive continued sales, the company offers many promotional options such as "Domino's Rewards" and "Mix & Match." With inflation causing consumers to "trade down" in the consumer discretionary sector, promotional offers like this should continue to lead to sustained sales in a tough economic environment. After covering many positives in their recent earnings call, the stock reacted positively, jumping over 5%. Although Domino's Pizza, Inc. may be a great company, the goal is to not overpay for the stock. Let's move into the fundamental analysis.

Fundamentals on DPZ

Domino's Pizza, Inc. is currently trading over 31 times forward earnings, a forward price to sales ratio of 3.61, and a forward EV/EBITDA ratio of 25. These value metrics are all slightly higher than their 5-year averages (mostly within single digits), however, when compared to the averages of sector peers, DPZ trades at a significantly higher price. But, this expensive relative sector valuation may be warranted if there are solid fundamentals. Looking over the last 10 years, Domino's Pizza, Inc. has significantly grown their revenues by 152% since 2013 and increased their gross margins by 28% in this time. While costs of goods sold (COGS) have also gone up 121%, DPZ has become more efficient, allowing for gross margin increase, thus maintaining returns for investors. As COGS continue to increase in a tough economic environment, gross margins are an area investors should focus on.

Return on Investments

Additionally, as DPZ has increased their revenues, they have also maintained a high return on invested capital (ROIC) over the last decade, while keeping their weighted cost of capital (WACC) low. As you can see in the graph below, DPZ's (ROIC-WACC) comparison shows that they have historically seen high returns on their investments compared to the costs. However, compared to 2013, ROIC was down 25% in 2022 and remains 7% lower currently over the trailing 12 months. Comparing WACC to 2013, WACC has increased by 2% in 2022, and 57% over the trailing twelve months. This demonstrates the increased costs the company faces from the current economic environment, and I would expect this to eventually subside unless we enter into a recession.

Cash Flow

Over the last decade, Domino's Pizza, Inc. has provided a 27% increase in free cash flow margin, now totaling 10.8% of net margins, as well as buying back 54% more of company stock than in 2013 for about 1.5% over the trailing twelve months. DPZ has produced a small but meaningful gain in free cash flow over the last decade while the dividend of the company has also increased 543% since 2013. As DPZ continues to grow, I would expect the company to focus on free cash flow margins and continue to provide growth in this area for investors.

Looking Forward

Based on DPZ's outline for continued growth, positive free cash flow, and share buyback ratio, I wanted to project out the next two years of earnings per share, dividends, and free cash flow using a linear projection model to see a general outline of where the growth is going. Additionally, following a discounted cash flow model based on earnings per share growth, I am evaluating the fair value for DPZ based on continued growth over the next ten years, and terminal growth for ten years after that. The graph below depicts the linear projection based on 10 years of data for where EPS, free cash flow, and dividends will be. As you can see, if business operations continue on this pace, EPS will be around $18 per share in 2026.

Dividend Growth

One positive about investing in a great company like DPZ is that it pays a dividend with a strong dividend history of 10 years and a 10-year CAGR rate of 19.72%. However, one pitfall of investing is chasing a dividend yield or company solely because it pays a dividend. With DPZ's payout ratio of only 34%, strong dividend history, and dividend growth, I expect the dividend to continue growing in the future but warn investors to not overpay for the shares given that the current yield is only around 1%.

Fair Value

Using a discounted cash flow model based on earnings per share growth, the current fair value of DPZ is $445.90 per share, which is about 14% lower than the current share price as of the close on May 28th. This was done assuming a 20% growth rate over the next ten years, with their current earnings per share of $15.31. DCF models rely on assumptions, and if we assume the growth rate of the company will be higher/lower than 20% over the next ten years, or assume a different discount rate, this value will change. However, based on the assumptions made here based on the historical 10-year average EPS growth, DPZ is modestly overvalued by about 14%.

Limitations to Investment Thesis

This valuation model above is conservative, assuming a 12% discount rate based on the unpredictability of continued earnings growth at 20% per share. Additionally, businesses are dynamic, and the economic environment is constantly changing. DPZ has navigated changes in the economy since they were founded in 1960 and has grown company revenue at a substantial rate. If DPZ can turn this rapid revenue growth into higher EPS by lowering the total cost of goods sold, as they had discussed in their earnings call last quarter, they should provide value to shareholders at a higher valuation. In their recent earnings call this quarter, DPZ highlighted a new innovation, with thin crust New York Style pizza, which may add in their ability to continue growing at a high rate, and thus posing a risk to this investment thesis.

This analysis is also limited by the assumptions I made in my calculations. If we change the DCF model assumptions slightly and assume that they will return $16.07 per share sooner, rather than the $15.31 I used, fair value would be $468.19. Additionally, if you assume EPS will be closer to $18 sooner than the linear projection for 2026, then fair value would also be higher. Depending on your outlook for the company's growth and earnings, your fair value price target may be different or even more optimistic than mine. You should also take into consideration the recent innovation the company made with their New York style pizza and if this will have a large impact on future earnings or not.

Conclusion

Domino's Pizza, Inc. is a growing restaurant chain that delivers growth to investors through product innovation and franchising locations. At the current price, DPZ is overvalued, and I expect the stock price will decline over the next 12 to 24 months once other investors realize it may be time to take some profits off the table. Based on my calculations above, I expect a price decline before I would warrant this to be within a fair value investment. However, if we do see a significant price decline, this would open up the opportunity for investors to buy shares of a great company that otherwise shows strong fundamentals. At this time, I am staying away from an investment in DPZ but would be happy to buy shares after a significant price decline if the fundamentals remain the same. This article is solely based on my own research and my own calculations for what I see as fair value.

Thomas Shields