During the October 5 episode of Mad Money, a longtime shareholder asked whether Domino’s Pizza, Inc. (NASDAQ:DPZ) still had substantial growth ahead, particularly internationally. Jim Cramer preferred to wait:
You know, this is a very tough one. What I’m going to do, I usually don’t like to punt like this, but they’re about to report, and they have a new CEO. And I just think when you have a new CEO, and you’re about to report, that’s a fraught moment to be able to make a stand on a stock. Let’s see how the new CEO handles himself. Let’s see how the company does, and then we’ll be able to make a better, more informed decision on DPZ, which was one of my biggest wins for a very long time. That was during the period when Pat Doyle ran it. He did a fantastic job.
Domino’s has more going for it than its familiar brand name. One part of its business model made hedge funds favor it.
Expansion Continues Under Familiar Leadership
Previously, Cramer had an interesting take when comparing Domino’s and Papa John’s. Domino’s Pizza, Inc. added 209 net stores during the second quarter, including 183 internationally. Global retail sales increased 3% excluding currency movements, while revenue rose 4.3%. Diluted earnings per share increased 6.8% to $4.07. The continued expansion provides a source of growth even when sales at existing restaurants are subdued.
The leadership change also involves an executive already familiar with the business. Joe Jordan, previously chief operating officer and president of Domino’s U.S., became CEO on October 1. His appointment offers continuity, although investors still need to hear how he intends to improve performance.
At approximately 15x forward earnings, Domino’s traded below Yum! Brands at roughly 21.9x. That discount provides some valuation support, although Yum’s restaurant portfolio differs from Domino’s pizza-focused operation. It is worth noting that Yum has narrowed its business around KFC and Taco Bell, but that does not necessarily make the stock the better restaurant play. The difference becomes clearer when you look at what its closest rival is doing differently.
Existing-Store Sales Remain Sluggish
New restaurants are doing more of the work than comparable sales. Second-quarter U.S. same-store sales increased just 0.1%, while international same-store sales declined 0.1% excluding currency effects. Those results give the new CEO limited evidence of improving demand across existing locations.
First-half free cash flow declined to $313.6 million from $331.7 million. Domino’s Pizza, Inc. management attributed the decrease partly to working-capital timing, including advertising payments, so the decline should not be treated entirely as a deterioration in fundamental demand. Nevertheless, stronger comparable sales would make the growth story more convincing than store openings alone. The upcoming results matter for more than the headline earnings figure. Investors will be looking for evidence that Jordan can improve customer spending and restaurant performance without sacrificing profitability.
A Modest Increase in Fund Ownership
The number of hedge funds holding Domino’s Pizza, Inc. rose to 47 in the second quarter from 45 in the first, according to Insider Monkey’s database of over 1000 hedgefunds. Among those funds, Soroban Capital Partners was the most prominent shareholder with 2.66 million shares. Short interest was 11.22% of the float. The increase in holders was modest, while the double-digit short position suggests that skepticism remains meaningful. Neither figure settles whether the current valuation adequately reflects the company’s slower sales growth.
Domino’s has an established expansion model and a valuation below a major restaurant peer. What it lacks is a clear acceleration at existing stores. Cramer’s decision to wait gives the incoming CEO an opportunity to explain how he plans to change that, before investors commit to a recovery that has yet to become evident.
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