Today's Buy Opportunity: Domino's Pizza

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Do you love pizza as much as I do? Well, I think I've found an investment that's as tasty as a fresh made-to-order slice of pie. For today's "11 O'Clock Stock," let's dig in to Domino's Pizza (NYSE: DPZ  ) .

Domino's fast facts

Market Cap

$757 million

Revenue (TTM)

$1.5 billion

Earnings (TTM)

$89 million

Cash/Debt

$29 million / $1.5 billion

Competitors

Papa John's (Nasdaq: PZZA  ) , Yum! Brands (NYSE: YUM  )

Source: Capital IQ, a division of Standard & Poor's.

We love pizza
I'm from New York and I love pizza. But I'm not the only one. We all seem to be a bit enamored of the little circle of wonder. In fact, pizza is a $34 billion-per-year business. To put this in some context, research shows that every man, woman, and child eats an average of 46 slices, or 23 pounds, of pizza each year. The delivery business represents about 26% of the total, and with a market share of about 18%, Domino's qualifies as the king of the delivery space.

Domino's operates a network of almost 9,100 franchised and company-owned stores in the United States and more than 60 international markets.

Three reasons to love Domino's

1. Revamped pizza recipe and expanded menu have re-energized the company
I'm sure you've seen the relatively new commercials highlighting the completely revamped pizza recipe and the expanded menu at Domino's. This new direction has worked perfectly for the company and has helped to significantly turn around the lackluster results for its domestic stores. Evidence of this is the latest quarter's U.S. same-store sales growth of 8.2%.

2. Significant international expansion opportunities
Much of Domino's growth is expected to come from its international operations, which have consistently generated strong results. The company's international stores (more than 4,000 stores) have posted 66 consecutive quarters of same-store sales growth. About 3,000 stores are concentrated in Domino's top 10 international markets such as Mexico, the United Kingdom, Australia, and South Korea. Management believes it can grow its top 10 international market total to 5,200, representing growth of about 75%.

3. Franchise model generates nice cash flow with minimal capex requirements
When done right, a franchised business model can be a thing of beauty. Domino's operates a large network of restaurants and collects a royalty stream from each. As a result, the business requires only minimal capital expenditures to operate.

Domino's U.S. franchises pay a 5.5% royalty based on the store's top-line sales, and the international franchises pay a 3.5% royalty. These franchise agreements typically extend for 10 years at a time. Furthermore, Domino's operates a successful supply chain division that ensures quality and consistency across the product line, leverages its purchasing power, and allows Domino's to pass through rising commodity costs to its franchisees. These supply-chain agreements also typically run for 10-year periods and allow for a 50% profit sharing agreement with the franchisees.

A little spicy
Domino's has a significant amount of debt, $1.5 billion to be exact. Profitability is sufficient to handle the interest payments, but a severe downturn in the business could cause some trouble. The company is committed to paying down this debt and has been making some good strides to do so.

Also, we need to keep an eye on the rising costs of cheese and wheat, two major components of pizza. Although Domino's can pass on much of these costs to its franchisees, I'd be concerned if increased raw material costs started eating into the profits of the stores, putting pressure on the franchises and making them less profitable.

Foolish bottom line
As the leading pizza delivery company, Domino's is well-positioned to continue to reap the profits of this large market. I'm impressed with the domestic turnaround and the strong international results. I think the international division will continue its strong growth trajectory. As long as the economy holds up, I think Domino's will continue to increase its free cash flow generation, and the stock could fetch about $17 per share, which translates to 25% upside from current levels.

Previous recommendations:

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Ron owns shares of Domino's. The Fool has created a covered strangle position on Papa John's International. Motley Fool Options has recommended a bull call spread position on Yum! Brands. The Fool owns shares of Yum! Brands. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 08, 2010, at 11:11 AM, brewersfan81 wrote:

    For a long time, I was looking to do an official write-up on DPZ, which I always do before making a purchase into my real-life portfolio. Erin definitely hit on the reason that I have avoided it for the time being: debt. And on top of that, stupid debt. Their recapitalization move a few years back was very short-sighted. It definitely gave a huge advantage to the short-term investor over the buy-and-hold investor, which I don't think is ever a good sign if you want to invest in a company.

    Now, with all of that being said, I still think DPZ is intriguing. Ron pointed out a lot of reasons in the video, namely: international expansion, and low cost, scalable model. Although it's included in the write-up, I think one of the most important changes DPZ has made was overlooked in the video: their improved pizza! I know as investors, we get caught up in things like margins, profitability, etc., but for God's sake, we've GOT to pay attention to what the pizza tastes like.

    I was at a family reunion a month back, and DPZ pizza was ordered. We decided to give it a try after the commercials we saw (which openly makes fun of how bad DPZ pizza is known for being), and the low price. It was 10X better than what I remember. The bread, the sauce, everything was better. I could care less about expansion and low capex costs if what they're offering is cardboard. But this is good pizza now!

    I think this represents shift in their culture, especially the honesty in admitting their mistakes. If their debt load continues to go down, and the quality of their pizza stays high, it will move up on my list.

  • Report this Comment On September 08, 2010, at 11:27 AM, citizenryan wrote:

    Absolutely love their new ad campaign. It's like something out of Don Draper's mind.

    Unique, direct with strong resonance.

    The campaign is an excellent indication of strong direction from the top.

    I'm in.

  • Report this Comment On September 08, 2010, at 11:33 AM, TMFGreedandFear wrote:

    brewersfan81,

    I completely agree with you about the importance of Domino's revamped pizza recipe and expanded menu. Those factors are responsible for the company's domestic turnaround and is an important part of the investment thesis.

    Right after we finished taping the video segment we realized that those points weren't highlighted. But, we made sure to include them in the write up so Fools would be aware.

    Thanks for the comments and Fool On!

    Ron

  • Report this Comment On September 08, 2010, at 11:34 AM, prime22 wrote:

    Is the ownership as politically right wing as it was historically. They funded virulent programs in opposition to reproductive rights for women.

  • Report this Comment On September 08, 2010, at 12:50 PM, TMFGreedandFear wrote:

    prime22,

    I'm not aware of anything like that.

    In 1998, Domino's Pizza founder, Tom Monaghan, retired and sold 93% of the company to Bain Capital, Inc. In 2004, Domino's completed an IPO. Bain Capital still owns about 14% of the stock. A new CEO, J. Patrick Doyle has been at the helm since march 2010.

    Best,

    Ron

  • Report this Comment On September 08, 2010, at 1:54 PM, plange01 wrote:

    domino's is all over tv begging people to buy their junk!!cant sell the foof its not worth buying the stock!

  • Report this Comment On September 08, 2010, at 4:55 PM, mpendragon wrote:

    I think the Domino's ad campaign over the last several months has been a mess.

    First, they come out with ads that bring attention to Papa John's claim of making superior pizza. It's important to note that Papa John's won the court case the Domino's ad was discussing so they've just brought more attention to that humiliating spectacle. Then, a couple of months later they bring out the sorry-our-old-pizza-was-gross-please-try-our-new-recipe ads.

    I think that's the wrong kind of attention.

  • Report this Comment On September 08, 2010, at 5:09 PM, oldengineer wrote:

    The Domino's pizza I used to buy about 27 years ago was good. Then I had to change stores and the pizza was not good. Over the years I quit buying from Domino's. After they changed their recipe recently, I tried it again and I still don't like it. In fact I don't know where to buy a good pizza. Papa John's - no.

    Donato's - no. Tony's Little Italy - no. Maybe the problem is with me and not Domino's, but I don't think so.

    OE

  • Report this Comment On September 08, 2010, at 6:14 PM, dangerscott wrote:

    > every man, woman, and child eats an average of 46 slices, or 23 pounds, of pizza each year

    Where is everybody finding half-pound slices of pizza?

  • Report this Comment On September 08, 2010, at 6:23 PM, TMFJoeInvestor wrote:

    Not to speak for Ron, but I wouldn't avoid a certain stock just because you might not like their food. I went to a Fool member event a couple of years back at a Chipotle where one member commented that she wouldn't buy the stock because she didn't like the food. Turns out she missed out on some pretty whopping gains just because she didn't like cilantro. Just sayin'.

  • Report this Comment On September 09, 2010, at 8:46 AM, wwt17 wrote:

    domino's pizza is ubiquitous in s. korea. we order it, not because it's delicious (it's just better than the korean version of pizza) or because it's cheap (rather expensive compared to korean food), but because we get a hankering for western food sometimes and it's a viable alternative.

    it might be a good business opportunity, but i get "cheezed" everytime i order and here's why. i'm a canadian bacon and pineapple guy, so this is what i usually order. when it arrives it's always hot (yes, they adhere to the "within 30 minutes" thaang here, too), and you get complimentary parmesian cheese powder packets and pickles (yes, pickles). the pizza tastes alright, but the BIG disappointment, and probable reason for it's finacial well-being in korea, is that there are a max of three pieces of pineapple on each slice of pizza (usally two) and the canadian bacon is some ghetto korean-made hotdog that's been thinly sliced. if i order extra pineapple, for something like the equivalent of a buck fifty, i might get 5 pieces of pineapple max per slice. it's not just the pineapple that they skimp on: it's all toppings. such a BIG DISAPPOINTMENT. i always feel like a taking a pic and sending it to domino's hq to complain, but what to what end? i'm sure they know what their business ops are in foreign countries.

    so, yeah the pizza's okay, but SHAME on domino's pizza for overcharging and being extremely stingy with toppings here in korea.

    wwt17 who eats it, but resents paying 25 bucks for a canadian bacon and pineapple pizza that is only some bread, a smattering of sauce, a sprinkling of cheeze, 20 pieces of pineapple and 30 pieces of ghetto korean-made hotdog.......

  • Report this Comment On September 09, 2010, at 12:37 PM, jrj90620 wrote:

    Not the greatest pizzas in the world and they have to give them away due to so much competition.Better places to invest.

  • Report this Comment On September 09, 2010, at 6:00 PM, penboy wrote:

    With the giant recapitalization, special dividend to directly benefit the largest shareholders (management?), sending the balance sheet into a wreck, it sets an example what the board are capable of doing. Would you trust your money to invest in this company?

  • Report this Comment On September 10, 2010, at 5:39 AM, wax wrote:

    Well I was going to question the wisdom of the selection but I see there are many others that beat me to it.

    Wax

  • Report this Comment On September 10, 2010, at 3:03 PM, SevenOneHands wrote:

    The latest figures are the seventh consecutive month of negative total score. Only one positive is UK retail sales volume up 3.4%. Claimant unemployment up to 0.82 million from 0.81 million. All three measures of inflation up and worse of all again for us is producer input and output prices to 27.9% and 8.9% on previous year (you only have to go back to Jan to find figures of just 1.8 and 2.8%). House prices in the UK down 6.4% on previous year and 2.3% on past three months.

    For the purposes of argument, here are my views on the different sectors:

    Banks - as shown by RBS, should not be touched with a bargepole. They are between a rock and a hard place; they're being forced to lend out money at a lower rate than they can afford and they are also being told to reduce leverage. These actions are contradictory. There is unfair competition between state owned banks and the rest, difficult to see how this is going to play out.

    Retail - will have some of the bad news priced in. According to the Sunday Times there are 15 major retail outlets that are going to struggle to survive until March. Apparently the average shop makes 3 times their normal profit for a month in December. If they're discounting by up to 50% that obviously isn't the case. I'm interested in retail but not for at least another 6 months - I want to see how much cash they've got to ride out the recession.

    Infrastructure - Building firms have been hit very hard. Olympics coming up and a number of government building projects have been moved forwards. This is a sector I've always avoided, I'd love someone here with some insights to give their views on the sector.

    Restaurants - seem to be doing surprisingly well at the moment. Average Joe doesn't seem to have realized that he should be saving money and not eating out. In a recession takeaways tend to do well. Domino pizza anyone?

    Commodities - I'm not an expert here, but I'd say that surely oil isn't going to remain at sub-$40 over the next couple of years. Another war in the middle east (Iran?) or just cold winter could make it interesting. A well timed long term trade must be a winner. Just make sure you stay away from those dodgy Russian oil companies, like SBE. Good cash reserves are a must.

    ----------------------------------

    Money without intelligence is like a car without a road.

    http://www.intelligentinvestingtips.com

  • Report this Comment On September 11, 2010, at 11:57 PM, billmichael wrote:

    All three of the "Big Pizza" chains (Papa John's, Pizza Hut, and Domino's) have products that are inferior and most of all, inconsistent. In fact, inconsistent quality is the number one reason I am inclined against delivery pizza. With any of them you may get a wonderful, fully cooked pie loaded with toppings or you may get an oversized cracker with mostly cheese on it. It's a crapshoot. In the pizza business, if you are a cook who doesn't care or know about what you are doing, you can cover your mistakes with acres of cheese and most people won't know the difference. The only kind of pizza chains I like now are Papa Murphy's "Take Away", Bearno's Little Sicily, and Wick's, which is a local favorite. If you are looking long term, the business model for delivery pizza is old and worn out. People buy it because they don't know any better. If you are looking for a growth industry, you should take a look at "premium" pizza like Bearno's or Wick's or Papa Murphy's take away. I think they are the future of pizza.

  • Report this Comment On September 12, 2010, at 12:06 AM, billmichael wrote:

    After thought: If someone could make a machine that actually manufactures pizza on-site so that quality is consistent and cleanliness is utterly guaranteed, you'd have a gold mine. The weak link in the business is the cook. No matter how fresh the ingredients, a cook who picks his nose and won't wash his hands then slops together a sick and scrawny pie leaves the entire business open for a takeover.

  • Report this Comment On September 15, 2010, at 11:50 AM, penboy wrote:

    For $14 per share, you are buying $-22 of negative equity(debt). Their strong earnings is still worth something, but one needs to account for the real risks of possible stock issuance to raise equity, debt roll over, interest coverage, capital structure covenants. I think the current beaten down PE is just reflecting the risks, not an opportunity.

  • Report this Comment On October 06, 2011, at 1:38 PM, XMFSmashy wrote:

    Ron didn't get much credit for this pick at the time, but he absolutely nailed it. DPZ is the single best performer out of all fifty 11 O'Clock Stock recommendations, currently up 95% from TMF's purchase price of $13.84. Well done, Ron!

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