At the end of July, Domino's Pizza Inc. (DPZ) reported a disappointing second quarter and the stock stalled. Domino's reports third-quarter results before the market opens on Thursday, Oct. 12. Can Domino's deliver?
After the first-quarter earnings report in April, I turned cautious on the shares of Domino's.
At the time, the stock was trading at a significant premium to the quick service restaurant (QSR) group. I thought investors should wait for a correction before ordering more pizza.
In July, Domino's reported second-quarter earnings of $1.32 per share, $0.09 better than expected. Revenue increased 14.8% to $628.6 million versus the consensus estimate of $609.9 million. Domestic same-store sales increased 9.5%, which represented the 25th consecutive quarter of upward momentum in the company's business. International sales grew 2.6%. During the quarter, the company added 217 stores -- 178 international and 39 domestic. Over the trailing four quarters, Domino's had 1,281 net new stores.
While last quarter looked good on the surface, it didn't take long for investors to spot trouble. Specifically, company store-level margins were crushed during the quarter. Margins were materially below expectations. Management blamed the drop on higher insurance adjustments (i.e., one-time expenses), but investors didn't seem to buy that excuse. The stock sold off on the news.
In addition, $0.04 of the $0.09 earnings beat came from a lower-than-estimated tax rate. Domino's reported a 25.7% tax rate, while analysts had modeled something close to the 37.4% the company reported last year. Given those factors -- and because international comps seemed lighter than many investors were expecting -- analysts began trimming estimates.
Year to date, shares of Domino's are up 29%.
Now, Domino's is poised to report third-quarter results, and I think this could be a pivotal quarter for the company.
Investors expect third-quarter revenue of $626 million and earnings of $1.22 per share.
Because this is the third quarter, investors will turn their attention toward guidance for next year. Analysts are looking for fiscal 2018 sales to increase 10.2% to $3.07 billion. Furthermore, analysts are forecasting earnings of $6.81 a share, which would be up nearly 30% year over year. However there seems to be widespread disagreement in the analyst community if Domino's can achieve those results. For example, the high estimate is $7.48 a share and the low is $6.25, a $1.23 difference. That's huge.
Back in July, Domino's announced a giant debt restructuring that allowed the company to yank out $970 million in excess cash. Some analysts believe that $970 million will be added to the current $1.25 billion buyback authorization, which would be used to prop up the stock (I mean return cash to shareholders).
All the buyback activity could add $0.23 to $0.25 per share to next year's earnings. Depending on your assumptions of tax rate, share count and margins, earnings could be much higher than the consensus estimate.
Oh, and it seems like nobody can agree on revenue growth, either. The consensus is looking for 10% revenue growth for next year, while the Domino's bulls are closer to 14%. As a reminder, Domino's grew revenue between 10.6% and 12.7% from fiscal 2014 to 2017 (estimated), so where the bulls are getting 14% revenue growth, I don't know, especially because Pizza Hut, which is part of Yum! Brands (YUM) , is rumored to be turning up the heat on pricing.
Add it all up and I remain cautious on shares of Domino's. I thought international comps were weak and this quarter might be sloppy considering soft television ratings for the NFL. The recent NFL protests might have an impact on sales as fans turn off the game and look for something else to do. While I like Domino's longer term, I don't think it can deliver this quarter.
