Chain pizzeria Domino's Pizza (DPZ 0.87%) has been a surprisingly successful stock for some time now. Share prices are up more than 2,300% since 2010 despite the fact that they trade near their 52-week low today.
The stock is down 45% from its peak, its most significant drawdown since the Great Recession. Is this an opportunity to pounce on this multi-year winner, or is the stock falling for good reason? Keep reading to find out what's cooled off Domino's Pizza and why investors should scoop up shares before they heat up again.
Why has Domino's stock fallen?
It's lazy to say a stock is cheap just because the share price fell. The stock could be more expensive than before if the fundamentals deteriorated. From a valuation standpoint, Domino's has taken quite a haircut. Shares trade at a price-to-earnings ratio (P/E) of 23, a notable gap below its long-term average of nearly 34.
So is Domino's cheap for a reason? The company's balance sheet is the most likely reason for tumbling. Domino's has spent years repurchasing shares, sometimes borrowing money during these years of low and zero-percent interest rates to do it. On the one hand, outstanding shares have fallen by 36% over the past decade.
DPZ Stock Buybacks (TTM) data by YCharts
But the company loaded its balance sheet with $5 billion in debt in the process, enough to leverage the company to more than 5 times its EBITDA, a ratio relatively high for comfort. For reference, I generally like to see this under 3. This balance sheet is a bigger problem as rates rise, making refinancing debt more expensive.
But the selling may have gone too far, for three reasons.
Reason 1: Domino's earnings growth should continue
Domino's earnings-per-share (EPS) grew by an average of nearly 20% annually over the past decade. Numbers don't grow as easily as they get larger, and the high probability of reduced share repurchases could also drag on growth. But that doesn't mean growth will fall off the rails -- analysts believe the company's EPS will grow by an average of 12% annually over the next three to five years. At 23 times earnings, a 32% decline from its long-term average, the stock seems at least reasonably priced despite lower growth expectations moving forward.
Reason 2: Domino's maintains a powerful competitive advantage
The pizza industry is remarkably fragmented, especially in the United States, where thousands of small independent operators still make up almost half the market. Domino's competitive advantage is that it's built a massive store network and uses technology to make the user experience quick and straightforward.
Your typical mom-and-pop pizzeria doesn't have an app to order on or the size and cost advantages to offer a product as good as Domino's at its price point. The low entry barrier for pizzerias means there are still plenty of opportunities to take market share, even if premium independents (the neighborhood's best spots) thrive over the long term.
Reason 3: Future growth opportunities are intact
On that note, investors should realize that Domino's isn't done expanding, even in the United States. Management believes there is room for another 1,500 stores in the U.S. market, and more than 10,000 incremental stores in international markets. It might happen a few dozen stores at a time, but this is a repeatable playbook that has been successful and still has legs.
Domino's Pizza had an epic run during a time of low rates. Now that Wall Street is holding the company's balance sheet against it, shares have cooled off. Look for management to reign its borrowing in, but continue with plentiful opportunities for organic growth. Consider adding Domino's here for the long term; the stock gets more appealing as the share price keeps falling.
