Why Domino’s stockholders’ deficit may be manageable

Stockholders’ deficit

Stockholders’ equity is calculated as total assets less total liabilities. When liabilities are more than the assets, the result is a stockholders’ deficit. As of third-quarter end 2014, Domino’s Pizza, Inc. (DPZ) had a stockholders’ deficit of $1.28 billion.

Accumulated loss

Domino’s stockholders’ deficit is a result of the company’s recapitalization efforts in 2007 and 2012. This deficit is funded with debt, which can burden a company with interest payments, resulting in a margin squeeze or a loss.

The company had a long-term debt of $1.5 billion as of third-quarter end. About one-third of the company’s debt, which carries an interest rate of 5.25%, will become redeemable in the coming year. Interest expenses were $19 million and the interest coverage ratio was 3.9x—calculated as earnings before interest, tax, depreciation, and amortization, divided by interest expenses.

Compare this to McDonald’s Corporation’s (MCD) 2Q14 interest coverage ratio of 15.8x , or Yum! Brands, Inc.’s (YUM) interest coverage ratio of 19.6x. The higher the interest coverage ratio, the better. But, as long as the company has strong sales resulting in higher earnings to service the debt, Domino’s low interest coverage ratio is not a negative.

The interest coverage ratio should be the focus for investors. But for those looking to mitigate this risk, considering a broader restaurant holding ETF such as the Consumer Discretionary Select Sector SPDR Fund (XLY), may be the way to go. This ETF also includes café stocks such as Starbucks Corporation (SBUX).

Next, we’ll look at the overall performance of Domino’s.