Shares of Domino’s Pizza ( NYSE:DPZ ) have historically proven to be an excellent long-term investment. Over the past 10 years, Domino’s stock has delivered a total return of about 430%. Comparably, the S&P 500 has delivered a total return of roughly 259% over the same time period.
In addition to having a strong long-term track record of delivering results for shareholders, Domino’s recently received the endorsement of legendary investor Warren Buffet. I don’t find Buffett’s decision to invest in the company surprising, given the fact that Domino’s is a high-quality, easily understood business trading at a reasonable price.
I believe the stock represents an attractive upside with a reasonably priced investment opportunity at current levels.
Domino’s Pizza: A high-quality business with Buffett backing
Domino’s, founded in 1960, is the world’s largest pizza company with more than 21,000 locations in more than 90 countries. While the company’s single largest market is the US, its international business is larger, accounting for approximately 14,702 locations compared to 6,930 US stores. The company operates on a franchise model and approximately 99% of locations are owned and operated by independent franchisees.
Domino’s primarily generates revenue by charging royalties to franchisees, as well as by selling food, equipment and supplies to franchisees. US franchisors are generally required to pay a royalty of 5.5% of sales, while international franchisors pay royalty fees of approximately 3% of sales on average. Supply chain sales revenue accounts for the largest portion of Domino’s total revenue accounting for approximately 63% of total revenue. Major competitors include other large pizza chains such as Pizza Hut, Papa John’s, Little Caesars and others. The company also competes directly with smaller local mom-and-pop operators. In the US, Domino’s is the market leader and is estimated to have 40% of the market for consumer spending on pizza in quick service restaurants.
Domino’s Pizza: A high-quality business with Buffett backing
Domino’s is a high-quality business in that it is able to generate very high returns on invested capital as the company’s franchise-focused business model is not very capital-intensive. As shown by the chart below, Domino’s has been able to consistently generate high levels of returns on invested capital. Additionally, the company’s business is also highly recession-proof, as pizza tends to be one of the cheapest dining options available to consumers, and spending at quick-service restaurants like Domino’s tends to benefit consumers who trade up from restaurants. more expensive during periods of economic challenges. .
Domino’s competitive advantage is driven by the company’s sheer scale and strong brand. The benefits of scale include better pricing power with suppliers compared to smaller players, as well as a larger store base to spread across the costs of R&D, marketing and advertising initiatives. Additionally, Domino’s sheer scale also allows its network to benefit from centralized technology spending. The Domino’s brand is well known and often associated with reliability and quality. These factors have allowed Domino’s to provide consistent revenue growth historically, despite the fact that the pizza business is highly competitive.
Domino’s Pizza: A high-quality business with Buffett backing
Warren Buffett’s Berkshire Hathaway ( Trades , Portfolio ) recently disclosed that, as of Q3 2024, it had purchased approximately 1.28 million shares of Domino’s. The position is worth approximately $550 million based on the current share price. While this investment isn’t one of Buffett’s biggest holdings, I wouldn’t be surprised to see Buffett increase his stake further from current levels, given the large amount of cash Berkshire currently has. Additionally, Berkshire’s stock currently accounts for approximately 3.7% of Domino’s stock, indicating that Berkshire can significantly increase its investment and not become an overly large owner of Domino’s stock, which could make it difficult to sell in the future due to liquidity constraints.
While Buffett has not commented publicly on Domino’s stock, the company has all the hallmarks of a classic Buffett investment in what is an easy-to-understand, high-quality business. Additionally, Buffett has made a number of investments in the food space historically including Coca Cola, Kraft Heinz, Dairy Queen, See’s Candies and others.
Domino’s shares initially rose about 10% after the disclosure of Berkshire’s investment on November 15, but have recently given up most of those gains. Domino’s shares are now trading about 4% higher than where they were before the disclosure of Berkshire’s investment. Thus, investors now have the opportunity to invest alongside Buffett without paying a significant premium relative to where the stock traded prior to the disclosure of his investment.
Domino’s stock currently trades at roughly 26 times consensus 2025 earnings per share. Comparably, the S&P 500 trades at roughly 22 times consensus forward earnings. While Domino’s clearly trades at a valuation premium to the broader market, I believe this is warranted given the recession-proof nature of the company’s high-quality business and solid growth prospects.
Over the past 10 and 5 years respectively, Domino’s has grown earnings per share at a compound annual growth rate of about 19% and 12%. Consensus estimates for FY 2025-2027 call for the company to report EPS growth of 6%, 10% and 7% respectively. However, I view these estimates as very conservative given the company’s strong historical growth trajectory and significant new store opportunities. In 2025, the company expects to increase its store count by 800 to 850, representing a store growth rate of approximately 4% based on the current store count of approximately 21,000. From 2026 to 2028, the company has said it expects to grow sales at an annual growth rate of 7%+ while growing income from operations at a rate of 8%+.
I believe the company’s earnings per share have the potential to grow even faster than operating income due to the impact of share repurchases. During the third quarter of 2024, the company repurchased 443,302 shares for $190 million, implying a purchase price of $428.6 per share, which is modestly below the stock’s current trading level. As of September 8, 2024, the company had an additional $926 million remaining under its share repurchase authorization, which amounts to nearly 6% of all shares outstanding based on current market prices. Historically, Domino’s has been a significant repurchaser of its own stock and has reduced its share count by approximately 38% over the past decade. I expect significant buyback activity to continue moving forward as the business does not require significant capital investment to grow given its franchise model.
Domino’s stock also looks reasonably valued compared to its quick-service restaurant peers. Papa John’s International ( NASDAQ:PZZA ) trades at roughly 19x consensus 2025 earnings per share, while Yum Brands ( NYSE:YUM ) , owner of Pizza Hut and other chains, trades at roughly 23x consensus 2025 earnings for action. While these companies have similar near-term growth prospects to Domino’s, I believe Domino’s premium is justified given its scale advantage in the pizza business.
It’s hard to argue that Domino’s is cheap given its premium valuation to the broader market and peers. However, I think the assessment is fair. The stock guru focus value also suggests that the stock’s current valuation is reasonable based on a wide range of metrics.
Perhaps the biggest risk to consider with Domino’s is its relatively high degree of leverage. At the end of Q3 2024, the company’s net leverage ratio was 4.9x. While this is an improvement from the 5.5x level during the same period a year ago, it is still a relatively high level of leverage. The vast majority of the company’s debt is in the form of fixed-rate notes, which carry relatively low coupons, as they were issued ahead of the 2022 rate hike cycle. The benefit of this is that the company enjoys a very low weighted average cost of borrowing of 3.8%. However, to the extent that interest rates remain high or rise from current levels, the company will eventually have to refinance its existing fixed rate debt at much higher rates, which could lead to increased interest expense.
That said, due to the company’s relatively predictable cash flow streams and capital-intensive business model, I believe the company can use the cash it generates from the business to depreciate over the next several years if rates move materially higher. from current levels.
Investment guru Warren Buffett (Trading, Portfolio) has said:
It is much better to buy a great business at a fair price than a fair business as a great price.
I see Domino’s as a great business at a fair price given its high-quality, recession-proof business model. The company has a long history of delivering solid results for shareholders through organic earnings growth and share repurchases. I expect these trends to continue and see the stock as an attractive investment at current levels.
