Domino's (NYSE: DPZ) has a new fan on Wall Street. An analyst at Nomura Instinet upgraded the stock this week and predicted market-beating gains ahead for the pizza-delivery giant's shareholders. As support for the upgrade, Nomura cited the company's international growth prospects, along with its relatively cheap valuation.
Let's take a closer look at why Domino's might be a good buy today.
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Timing is everything
No one would accuse analyst Mark Kalinowski of having bad timing. After all, Domino's stock had slumped 22% from the high it reached in June when he issued his upgrade. And over the same time, the broader market rose by 9%.
Pizza Hut owner Yum! Brands (NYSE: YUM) is up 30% so far this year, or about double Domino's gain. Thus, Kalinowski isn't exactly going out on a limb by recommending a stock that's been rallying and setting record highs.
Domino's isn't putting up weak operating numbers, either. On the contrary, comparable-store sales jumped 8% last quarter. And while that represented a deceleration from the prior quarter's 9.5% spike, it was still enough to trounce Pizza Hut's 3% gain and the 1% uptick that Papa John's managed.
The pizza chain is also busily expanding its store footprint both at home and in other markets like Brazil, Japan, and India. It added 217 new locations last quarter and has boosted its base by 1,200 stores over the last 12 months.
That growth pace played a role in this latest upgrade, as Kalinowski cited international expansion as a good reason to own this business. After all, its brand strength and light business model should allow Domino's to build its overseas business well beyond the 7% of sales that it currently generates. "As Domino's continues to grow," he said in his note to clients, "we believe that this is placing more competitive pressure on local and regional international pizza chains."
Risks and valuation
But Domino's needs to post consistently healthy sales growth in these markets to justify such an aggressive expansion pace. And while international comps improved to a 5% rate in the third quarter, they're still running behind last year's growth. So keep a close eye on this metric over the coming quarters. If international comps weaken again, then Domino's might need to rethink how quickly it can expand its sales footprint.
Debt is another big issue to watch, given that the company's $3.2 billion of borrowings represent almost 40% of its total market capitalization. Interest payments on those loans passed 5% of sales last quarter, up from 4.4% in the prior year. This drag is easily covered by quickly expanding revenue today. However, it could grow into a significant burden during an economic downturn.
As for its valuation, it's hard to argue with Kalinowski's claim that Domino's stock is looking cheaper right now. Its price-to-earnings ratio has come down from almost 50 to roughly 35, and that's a tempting discount on a business with such promising growth opportunities both in the U.S. and international markets.
Domino's share of the pizza delivery business touched a dominant 27% last year, up from 19% a decade ago. And nothing in its recent results implies that this positive momentum is about to end. Thus, if you're open to the idea of investing in a debt-heavy business, this stock could be a good buy following its underperformance through most of 2017.
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