Domino’s Pizza (NYSE:DPZ) has attracted mixed investor sentiment following the company’s mixed fiscal Q2 results, with the company posting its worst revenue growth since the Great Financial Crisis. The market-leading pizza franchisor is currently facing challenges on multiple fronts, including pricing pressures as consumers attempt to save money during a tough macro environment and weak same-store sales growth in the U.S. It’s not clear that this is cause for worry, though.
While Domino’s pizza growth metrics were indeed somewhat underwhelming for the second quarter, it’s hard not to praise the company’s ability to expand its margins and grow its profitability further despite the highly-inflationary landscape of the past year.
In fact, Domino’s Pizza’s current bottom-line trajectory points toward a strong rebound in profits this year and further growth to new all-time highs in Fiscal 2024. With DPZ shares trading at a relatively attractive multiple against the company’s earnings growth potential, I am bullish on the stock and am not concerned about the Q2 results.
Inflationary Pressures Suppress Customer Spending
Domino’s Pizza faced significant challenges due to inflationary pressures over the past year. The prices of food ingredients, in particular, experienced a sharp increase, leading to higher costs in sourcing these ingredients. Consequently, the company had no choice but to pass on these costs to its franchisees, who then had to pay more for the delivery of these ingredients.
In addition to the rising ingredient costs, Domino’s also had to account for higher labor expenses caused by staffing issues in a tight labor market with wages on the rise. To maintain their margins, the franchisees would have to raise menu prices.
Indeed, the company implemented price hikes, with specialty pizzas now starting from $11.99 for the small size (and we all know how small these pizzas are). Naturally, these price hikes weren’t well-received by consumers, who, if anything, expect value for their money from all “fast-food” chains like Domino’s.
However, note that this inflationary pressure wasn’t unique to Domino’s Pizza. All fast-food and affordable chains experienced price increases, and even cooking at home offered little respite as groceries had also become more expensive. Consequently, while the demand for Domino’s pizzas didn’t decline considerably, consumers opted to be more selective with their menu choices to save money.
Hence, the average basket pricing to stores fell by 2.4%, which, combined with slightly lower sales volumes, led Domino’s Pizza to post a revenue decline of 3.8% to $1.03 billion. This marked the company’s worst top-line year-over-year result since Q3 2009 during the Great Financial Crisis when revenues had fallen by 6.5%, making it a concerning headline for investors.
That said, investors should also pay attention to the company’s margins and bottom line, which showed notable improvements despite the challenges.
Domino’s Profitability Remains Exceptional, Nonetheless
While Domino’s required, in a sense, pricing hikes weren’t necessarily happily received by customers, the effect on revenues wasn’t that destructive. In fact, the company’s updated pricing and menu bundles allowed the company to realize higher margins compared to last year. Specifically, gross and net margins in the second quarter landed at 39.5% and 10.7%, respectively, up from 36.3% and 9.6% in the prior-year period. Therefore, net income was $109.4 million, up 6.7% compared to last year despite the weaker top-line result.
Profits to Rebound in Fiscal 2023, Hit New Records in Fiscal 2024
Despite the underlying challenges, Domino’s Pizza’s strong profitability in Q2 is expected to last through Fiscal 2023. Inflationary pressures have started to ease, which, combined with the company’s sturdy pricing strategy, should allow its improved margins to persist during the second half of the year. Accordingly, Wall Street analysts expect the company to post earnings per share of $13.67, implying a year-over-year increase of about 9% compared to Fiscal 2022’s earnings per share of $12.53.
While this is still lower than Fiscal 2021’s peak of $13.53, consensus earnings-per-share estimates for Fiscal 2024 project a result close to $15.70, implying continued bottom-line tailwinds and a new record in Domino’s profitability.
Is DPZ Stock a Buy, According to Analysts?
Regarding Wall Street’s sentiment, Domino’s Pizza features a Moderate Buy consensus rating based on 12 Buys, seven Holds, and two Sells assigned in the past three months. At $409.43, the average Domino’s Pizza stock forecast implies 2.7% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell DPZ stock, the most accurate analyst covering the stock (on a one-year timeframe) is Chris O’Cull from Stifel Nicolaus. He boasts an average return of 28.22% per rating and a 94% success rate.
Takeaway – A Compelling Investment Case Despite Mixed Sentiment
Domino’s Pizza has attracted mixed sentiment lately. On the one hand, the market recognizes that this is one of the highest-quality companies within the QSR (quick-service restaurants) space. Domino’s has historically been considered a long-term holding, with the expansion of the franchise still having considerable room for growth. This explains Wall Street’s Moderate Buy consensus. This is not a stock you investors want to get rid of anytime soon.
On the other hand, Wall Street’s soft price target puts pressure on the stock’s investment case, as its rather weak top-line results may have discouraged some analysts from being too bullish on the stock.
Regardless, I believe that Domino’s Pizza stock price decline from its late 2021 highs (over $550) offers a compelling buying opportunity. At 25x its Fiscal 2024 earnings, I believe that the company trades at a decent multiple given its incredibly strong brand, ability to maintain exceptional profitability amid a highly-inflationary environment, and international growth prospects.
Few companies in the QSR sector can match Domino’s efficiency and margins, achieved through its stellar supply-chain management and smooth cash-flow mechanism, with most of its restaurant revenues coming from royalties.
With earnings set to rebound strongly and the macro environment likely to continue improving in the coming years, Domino’s Pizza’s earnings growth potential remains very strong. Hence, investors seeking exposure to the QSR industry will likely find DPZ stock a compelling opportunity.
