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Is It Time for Investors to Sell Domino’s Pizza?

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  • Domino’s Pizza stock has increased too fast.
  • The company could face competition from other big players in the delivery business.
  • The current valuation multiples look expensive.

Earlier, I was bullish on Domino’s Pizza (NYSE:DPZ). However, the stock has moved up too quickly for my comfort. So far this year, the company has handsomely outperformed the broader equity markets. YTD, Domino’s Pizza has returned 26.4%, while the S&P 500 Index has fallen by 11.2%. Amid social guidelines, most restaurants closed their dine-in spaces. They only operated takeout and delivery services. Independent players might struggle to only operate with takeout and delivery services. Since Domino’s Pizza has established delivery channels, it could gain market share from independent restaurants amid the crisis. As a result, the company’s stock price rose.

However, in the latest quarter, the company reported an SSSG of 1.6% in the US and 1.5% in the international markets. So far, the assumption that Domino’s Pizza would gain market share from independent restaurants hasn’t turned out to be true.

Competition in the delivery business could increase

Domino’s Pizza has been a pioneer in the delivery business. The company has been implementing technological advancements to provide a frictionless delivery service. As of last quarter, the company’s digital sales contributed 65% of its overall sales. Domino’s Pizza has developed innovative ordering platforms. Customers can order from Google Home, Facebook Messenger, Apple Watch, Amazon Echo, and Twitter. Also, the company introduced Domino’s Hotspots in 2018. Customers can get their orders delivered to 200,000 unique and non-traditional locations.

However, Domino’s Pizza could face completion from the entry of other big players, like Chipotle Mexican Grill (NYSE:CMG) and McDonald’s (NYSE:MCD), into the delivery space. With the outbreak of COVID-19, major restaurant players have started to implement delivery services in all of their restaurants. Also, food delivery companies like GrubHub, Uber Eats, DoorDash, Postmates, and Caviar have made it easier for companies to implement delivery services. I think that these new players could gain market share from Domino’s Pizza in the delivery business, which would lower its sales.

Domino’s Pizza’s valuation multiples look expensive

As of May 5, Domino’s Pizza was trading at 34.0x analysts’ 2020 EPS estimates of $10.92, at 31.3x analysts’ 2021 EPS estimates of $11.88, and at 27.7x analysts’ 2022 EPS estimate of $13.40. These estimates represent a YoY growth of 14.1%, 8.8%, and 12.8% in those years, respectively.

However, the company’s revenue growth has been slowing down. After reporting double-digit revenue growth for five years, Domino’s Pizza posted revenue growth of 5.4% last year. Some of the declines were due to refranchising company-owned restaurants. Meanwhile, the company’s SSSG has also been slowing down. In 2019, the company posted an SSSG of 3.2% in the US and 1.9% in the international markets.

Despite the slowdown in its revenue growth, the company’s EPS rose by 13.7% last year. Domino’s Pizza repurchased shares worth $699.0 million in 2019, which contributed to its EPS growth. However, the company only generated $497 million of cash from its operating activities. So, the company has to borrow to fund its repurchase programs. Domino’s Pizza can’t continue to borrow to fund its repurchase program. Also, the debt levels have increased from $2.28 billion in 2015 to $4.38 billion in 2019.

My take

Although Domino’s Pizza has an excellent business model, I think that its recent surge has pushed it into overbought territory. The company’s valuation multiples look expensive amid the slow down in its revenue growth, flat EBIT margin, and rising debt. So, it would be wise for investors to book profits and look for other avenues with growth opportunities.

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