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Investors Should Consider Domino’s Pizza before Its Q2 Earnings

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The food service industry has been struggling due to the temporary closure of the dine-in places. However, Domino’s Pizza (NYSE:DPZ) has returned 35.6% YTD. The company has a well-established delivery channel, which has given it an edge over its peers. In a business update in May, the company’s management said that its SSSG in the US grew by 14% in the first two months. 

Also, Domino’s SSSG in international markets increased by 1%. Amid the lockdown, customers relied on delivery and carryout options, which boosted Domino’s sales. So, the positive update and impressive first-quarter performance drove the company’s stock price. Meanwhile, the company will likely report its second-quarter earnings on July 16. Should you buy the stock before its earnings? First, let’s look at analysts’ expectations for the quarter. 

Analysts’ revenue expectations for Domino’s

Analysts expect Domino’s Pizza to report revenues of $910.4 million in the second quarter. The amount represents a growth of 12.2% from $811.6 million in the same quarter of the previous year. I think that the positive SSSG and net addition of new restaurants in the last four quarters could drive the company’s sales. However, the temporary closure of dine-in places might be a drag on the company’s sales.

At the end of the first quarter, Domino’s operated 345 company-owned restaurants—12 restaurants more than it operated at the end of the second quarter of 2019. During the same period, the company’s franchised count increased by 763 units to 16,744. These new restaurants and the restaurants that opened in the second quarter could drive Domino’s revenue.

Amid the pandemic, there was a surge in the demand for delivery and carryout services. So, the company invested in technology and hired more employees to meet the demand. In the US, Domino’s implemented a 100% contactless delivery model and drive-up carryout model to improve customers’ safety. All of these initiatives could contribute to the company’s second-quarter SSSG. 

Domino’s EPS could rise marginally

Although Domino’s top line will likely rise by double-digits, analysts expect its EPS to rise marginally by 2.3% to $2.24. The sales growth and share repurchases will likely drive the company’s EPS. However, the lower EBIT margin, increased interest expenses, and a higher effective tax rate could be a drag on the company’s EPS.

Analysts expect Domino’s EBIT margin to contract from 9.7% to 4.6%. Increased hygiene-related expenses amid the pandemic, additional employee bonuses, and increased delivery and carry-out costs could lower the company’s EBIT margin. However, the sales leverage from positive SSSG could offset some of the declines. 

Dividend yield and valuation multiple

On April 21, Domino’s board announced quarterly dividends of $0.78 per share, which represents an annualized payout of $3.12 per share. As of July 10, the company’s dividend yield stands at 0.8%, which is on the lower side. On the same day, Papa John’s (NYSE:PZZA) and Yum! Brands (NYSE:YUM) dividend yields were 1.01% and 2.15%, respectively. However, the company’s net cash outflow is positive. So, Domino’s is well-equipped to distribute dividends in the future.

The recent surge in Domino’s stock price has pushed its valuation multiple higher. As of July 10, the company was trading at 33.7x compared to its average forward PE ratio of 28.3x over the last three years. On the same day, Papa John’s and Yum! Brands were trading at forward PE ratios of 51.1x and 25.9x, respectively.

Analysts are bullish on Domino’s

Wall Street is bullish on Domino’s Pizza. Among the 28 analysts, 60.7% recommend a “buy,” while 39.3% recommend a “hold.” None of the analysts recommend a “sell.” Since the beginning of July, RBC, BTIG, Wells Fargo, Oppenheimer, MKM Partners, and CFRA have all raised their target prices. Meanwhile, CFRA also upgraded the stock from a “hold” to a “buy” rating. Analysts’ consensus target price was $401.8, which represents a return potential of 0.9%.

My take

Overall, I’m bullish on Domino’s Pizza. Before the pandemic, independent or individual-owned restaurants acquired over 50% of the pizza market. However, due to lockdowns, restaurants across the US had to operate with only delivery and carry-out services. Independent restaurants struggled to survive with limited services. 

As a result, many independent restaurants closed. I think that Domino’s, with its well-established delivery channels, could capture the market share from these independent restaurants. I think that investors should buy the stock before its second-quarter earnings. 

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