Domino’s Pizza Inc. – Intrinsic Value
Domino’s Pizza is the third largest publicly traded fast-food chain in the world. With over 18,800 locations worldwide, the business model is three pronged with franchising as the primary profit center. However, it has one glaring flaw, the company is highly leveraged to the tune of more than $5 Billion. There is ZERO equity in this company. It’s average annual earnings over the last five years are around $380 Million. The interest expense alone has almost doubled from $99 Million in 2016 to $192 Million in 2021; this is in five years.
Even with an average annual earnings of $525 Million per year, it will take 10 years to get the debt under control. Domino’s Pizza Inc. keeps recapitalizing its debt every couple of years. This recapitalization process increases the aggregated interest paid and given the current Federal Reserve’s attitude towards interest rates, this is going to be a detrimental problem for Domino’s in a few years. The weighted average borrowing rate is currently 3.8% and will remain stable for several years due to timing issues. However, there is a $1.2 Billion refinancing requirement in 2025 which will most likely result in an increase in the average borrowing rate. Thus, the ability of Domino’s to continue profitability at more than $600 Million per year after 2025 is questionable.
To add additional risk to the shareholders, the respective notes require that if Domino’s Pizza Inc. fails to comply with the terms of the respective notes, the notes are guaranteed by the royalties Domino’s generates. In effect, the respective note holders even move to the top of the income statement in front of expenses to operate Domino’s if Domino’s fails to make their obligated interest debt service payments.
What does all of this mean?
It means that Domino’s Pizza Inc. is a high-risk, low-reward investment at the current market price. There is no foreseeable value to a shareholder other than dividends. Its current cash flows indicate that any excess cash is used to buy back stock at current market prices shifting intrinsic value out of the company via treasury stock. Current dividends per share are $3.96 with a current market price per share of $380 (Mid-April 2022) generating a yield of 1.04%. The standard for a reasonable dividend yield with reasonable risk exposure is around 2.8 to 3.1% making this stock’s MAXIMUM value around $132 per share. But the key term here is ‘REASONABLE RISK‘ and Domino’s risk is simply off the charts with a leveraged position of $5 Billion. A more realistic dividend yield given this risk exposure is more than 4.5% making the maximum an investor would want to pay around $88 per share.
Another approach towards evaluating intrinsic value is to use the Graham and Dodd formula for total earnings less total debt. Current average earnings using a weighted based formula giving greater emphasis on more recent earnings results in the following estimated outcome:
Value = [Earnings X ((8.5 + (2X Growth))] Less Debt
Value = [$480M X ((8.5 + (2X 4.25%))] – $5 Billion
Value = [$480M X 17] – $5 Billion
Value = $8.160 Billion – $5 Billion
Value = $3.16 Billion
There are currently 36.14 Million shares outstanding. This means each share is worth approximately $87.44.
The key to this formula is the growth rate; notice that it is set at 4.25%. This growth rate is strongly tied to the increase in the number of stores worldwide. During the last three years, the number of locations increased 18.4% which averages more than 5% per year. Based on this, an analyst would assume a stronger growth rate than the 4.25% used; however, growth isn’t purely based on location increases. Growth is a function of not only increases in locations, but increases in revenue. Revenues per location have not kept pace. Average annual sales increases per store is less than 4%; thus, weighing down the overall growth rate.
Finally, related to the Graham and Dodd model, their formula assumes reasonable risk factors for the entity’s analysis. As stated already, Domino’s Pizza Inc.’s risk is unreasonably higher due to many factors. The most onerous being the lopsided balance sheet. Therefore, the formula’s result of $87.44 is quite liberal; the actual value is dramatically lower.
Overall, the intrinsic value of this company has been gutted by several factors:
- A leveraged debt position of more than $5 Billion;
- Interest payments that have almost doubled in five years;
- Cash Flows that are oriented towards buying back stock and not reducing debt;
- A business model that is highly dependent on expansion of locations to generate growth in revenue.
Domino’s Pizza Inc. – Intrinsic Value
Value investors are keen to risk reduction and as such, intrinsic value is determined from a position of reasonable risk and stability. Domino’s has no reasonable risk as an investment. This drives intrinsic value much lower. Furthermore, Domino’s Pizza is highly dependent on growth from franchise expansion to increase revenues and the bottom line. Domino’s business model requires a deep discount against intrinsic value in order to substantiate ownership of any securities in Domino’s Pizza.
Given the above information, intrinsic value is set at $70 per share with a buy price set at a 25% discount to intrinsic value, $52.50 per share.
Domino’s Pizza Inc’s current stock market price is driven by Domino’s Pizza Inc.’s growth model and not founded in sound financial analysis. This company is going to have many years of financial woes even with good growth. Act on Knowledge.
© 2022, David J Hoare MSA. All rights reserved.