After a brilliant run, bears say Domino's Pizza (NYSE:DPZ) has hit a wall. The pizza refresh that started a decade ago is done, and the investments made in its digital platform have served their purpose, but can no longer be counted on for growth. The premier fast-pizza shop has reached its peak and is now on a course for slow growth from here.
While that argument can be made with some authority after Domino's recent quarterly earnings missed analysts' expectations, it ignores the company's continuing investments that support further gains to come.
Pizza has cooled off
In the third quarter, revenue jumped 22% to $786 million at Domino's, supported by a 6.3% increase in domestic same-store sales. This helped the pizza chain notch a 49% increase in net earnings, which reached $84.1 million. A number of one-time adjustments occurred during the period, such as the adoption of new accounting standards and gains on the refranchising of a dozen company-owned stores, but it was a solid effort overall.
What dragged down Domino's stock was the fear that its big growth days are over. There was significant deceleration in growth across the board, with systemwide retail sales growth falling into single-digit territory from double-digit gains last year (though the growth slowdown was less dramatic when foreign currency exchange rate fluctuations are accounted for).
There's also been deceleration during 2018, as comp sales growth was slower in the third quarter than in the second quarter, which itself experienced slower growth than the first quarter. But results have been even worse across the rest of the industry. Yum! Brands' Pizza Hut chain experienced flat sales on a 1% comp sales drop in the second quarter, while Papa John's International (which has its own issues to sort out) saw sales and domestic comps fall 6% in the second quarter. Other chains aren't faring well either.
Domino's results could just be another indication that we've hit peak pizza, rather than pointing to any problem with the pizzeria itself, but that wouldn't dispel the notion that it is on a course for slow growth. Yet there's still a lot to recommend the pizza chain as a growth stock.
A technology leader
Domino's has differentiated its brand from the competition, changing recipes for its pizza and even changing how you order. It remains a leader in food delivery that has driven gains through its technology investments that continue today. For example, earlier this year it launched Domino's Hotspots, which enables it to deliver pizza to 200,000 nontraditional locations like parks and beaches. It's a one-of-a-kind innovation in the industry that will allow Domino's to continue its record of solid execution.
Pizza is still highly fragmented, with most pizza shops being independently owned and operated, but that gives Domino's the opportunity to continue grabbing market share in the $134 billion worldwide pizza market.
Because Domino's is almost completely franchised, the company probably won't need high capital expenditures to continue its growth. This will allow it to produce generous levels of free cash flow. Although its dividend yields a modest 0.8% currently, strong cash flow will allow Domino's to raise the payout or buy back more stock.
Shares have fallen 12% from their recent highs, but investors should see that as an opportunity to buy into a strong, stable business with plenty of growth opportunities in front of it.
Rich Duprey has no position in any of the stocks mentioned. The Motley Fool is short shares of Papa John's International and has the following options: long November 2018 $55 calls on Papa John's International. The Motley Fool has a disclosure policy.