For a while now, revenue growth for Domino's Pizza (DPZ 2.33%) has been pretty hard to beat. With five years of double-digit sales growth, this has easily been one of the best-performing investments to have in a portfolio. At the same time, the balance sheet continues to create concern. Domino's runs an equity deficit, making continued expansion essential to the stock's health.
Through the last five full fiscal years, annual revenue has climbed 172%, to reach $3.43 billion in fiscal 2018. In that same time frame, annual net income has risen 122.6% to $361.97 million. This wasn't lopsided growth, either: It includes strong double-digit gains in net income. On a per-share basis, earnings grew by 43.29% in 2018 alone. It's not hard to see why this stock has been on fire over the last decade, handily beating the S&P 500 annually.
Balance sheet issues
With this kind of growth, how could I possibly be nervous about the stock? Well, Domino's also has some serious debt. In those same aforementioned years of growth on the income statement, it created huge liabilities on its balance sheet. These are so great now that they outweigh the gains created elsewhere.
Image source: Getty Images
Long-term debt has expanded annually, reaching $3.5 billion in fiscal 2018. As of the end of Q1 2019, total equity in the company was actually negative $2.9 billion. Ironically, the stock has a market capitalization of over $10 billion. These figures could account for the stock price decline after the company reported second-quarter results in mid-July that underwhelmed analyst estimates.
In comparison to growth rates in fiscal Q2 2018, comparable-store sales slowed in the second quarter of this fiscal year.
- U.S. store sales grew 3% in Q2 2019 compared with 6.9% in Q2 2018.
- International sales increased 2.4% in Q2 2019 versus 4% in Q2 2018.
- Total retail growth slowed to 5.1% in Q2 2019 compared with 12.6% in Q2 2018.
I'm worried that this might have been the first real sign of a crack in the unbridled growth story. If things continue to slow, it could put a damper on the belief that Domino's can create growth that justifies the stock price and balance sheet.
Upcoming earnings report will offer clues
Analyst estimates have Domino's putting up $2.05 per share this quarter when it reports earnings on Tuesday, Oct. 8. For the full year, estimates place earnings at $9.42 per share. That would mean the stock is trading around 25.7 times forward earnings. When you factor in the disparity between book value and market capitalization, Domino's seems high risk.
Pizza is a game that never seems to lose. Nonetheless, there is a lot of competition in the industry, and it's not ridiculous to say that other names could begin to encroach on Domino's market share. Moreover, any recession in the United States or abroad could lead to lower overall transactions and/or same-store sales rates for Domino's.
If Q3 2019 same-store sales don't increase at a higher rate than Q3 2018, we might see some more downside here. As I said, the equity deficit means Domino's must grow to substantiate its stock price. It's a high risk/reward situation.
