Domino’s Delivered Another Strong Quarter, Yet Shares Fell

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In this Market Foolery podcast segment, host Mac Greer, Total Income's Ron Gross, and Motley Fool Pro and Options' Jeff Fischer dig into the third-quarter earnings report that Domino's (NYSE: DPZ) released Thursday. Taken on its own, the report looked excellent. However, as they explain, it's all about the trend lines. Investors in a stock trading at this earnings multiple don't just want to see growth, they want to see accelerating growth. And they didn't.

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A full transcript follows the video.

This video was recorded on Oct. 12, 2017.

Mac Greer: Domino's, reporting better-than-expected earnings on Thursday. Ron, I see these numbers and I see some pretty strong same-store sales numbers, but shares of Domino's, down today. What's going on?

Ron Gross: I don't know.

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Greer: Thank you.

Jeff Fischer: [laughs] Next topic.

Gross: [laughs] I think we're getting tripped up, and rightly so, on the better-than-expected phrase. But then, the actual reason the stock is down, it's because same-store sales were up 8.4%. Not too shabby, right? But, versus 13.8% this time last year. So growth is slowing, and the market is selling the stock off as a result. But yet, as you rightly said, they were better than expected, so that makes no sense. We can conclude here that the market makes no sense in the short term. And on any given day, the headlines can be misleading. You don't know exactly why people are selling off stock. These numbers are fantastic. They continue to be fantastic. You can't be unbelievably fantastic forever. So growth is slowing. But as I said, international store sales up 5.1%, that's 95 consecutive quarters of positive international same-store growth.

Fischer: Ninety-five?

Gross: Ninety-five. In the U.S., it's 26 consecutive quarters. The company has obviously knocked the cover off the ball over the years, starting from the time where they admitted their pizza was not too great, and they put a whole marketing campaign about that and were quite honest with consumers, which I love. We've talked about that before. You love it as well. Since then, it's just shown up in the numbers.

Another really important thing they did was they identified the franchisees that were not doing a great job, and they took the franchises away from those, reallocated them to folks who were going to do a better job. So that, in conjunction with the marketing campaign and making the pizzas taste better, really drove the expansion over the last six, seven, eight years.

Fischer: And a reason the stock may be cooling off after results is, the shares do trade at 40 times earnings. So that valuation multiple that Ron just talked about has really expanded for years for a long time now. And for comparison, Papa John's, which is maybe the strongest like-minded competitor, trades at 25 times earnings. Now, Papa John's has been struggling lately compared to Domino's.

Gross: And Yum!'s Pizza Hut, 29 times. That's a fair comparison as well.

Fischer: So they all get a premium, but Domino's far and away is at the highest premium.

Gross: You know, an interesting thing that they're doing, and some other companies like Jimmy John's have done it, they're doing a recapitalization, where they're basically selling bonds -- in this case, $1.9 billion worth of bonds -- and securitizing it with all the revenue of the company, all the different ways the company makes revenue. And they're getting a better interest rate than they normally would have by pledging all of these streams. And they've done this before, and it's kind of a trend we're seeing, and they're able to borrow at a rate, buy back bonds that are trading with higher interest rates, recapitalizing the company a little bit. They did a $1 billion advanced share repurchase program with one counterparty to take some shares off the table. So a nice recap at the same time that they're able to do, as the cash flow is streaming in.

Greer: Ron, I want to allow you to take a victory lap here.

Gross: [laughs] I don't like victory laps.

Greer: You're being modest, but a lot of people who don't follow Domino's may be surprised to know that back in 2009, the stock traded at $5.28. And I mention that because that's when you recommended the stock.

Gross: Yeah, November 2008, actually.

Greer: 2008, $5.28. Today, stock closer to $200 a share.

Gross: Not too shabby.

Greer: So, what did you see back then?

Gross: I don't like victory laps, because then I have to apologize for the ones that don't go right. So I try to be even-keel.

Greer: You've held the stock, and you never have to --

Gross: No, I sold the stock a long time ago. I did very well, I'm not complaining, but nowhere near this well. And what I saw in the stock was kind of what we just mentioned, that the company was about to revamp the whole business, from the taste of the pizza to the marketing campaign to replacing the poor B- or C-level franchisees. And it seemed to me that was a pretty good bet at that point from a value investor perspective.

Greer: And let's talk about that marketing campaign. As you mentioned earlier, it's incredibly self-deprecating. They showed focus groups. They acknowledged that one of the most common criticisms of their pizza was that it tasted like cardboard. And I love that. Because then you root for the company. They're being honest with me.

Jeff Fischer owns shares of Papa John's International. Mac Greer has no position in any of the stocks mentioned. Ron Gross has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.