Bill ackman (Trades, Portfolio) by Pershing Square Holdings Ltd. announced that it had sold its stake in Starbucks Corp. (SBUX, Financial) and invested in Domino’s Pizza Inc. (DPZ, Financial).
At the Wall Street Journal’s Future of Everything festival, he Explain, “We sold Starbucks. The price was that it was hard to get the excess return that we love to earn … The stock just recovered too quickly.”
As for the purchase of Domino, he noted that its share price had dropped dramatically for “reasons we didn’t understand”, allowing Starbucks to be traded for Domino’s. He couldn’t buy as much as he would have liked, but still got almost 6% of his shares back.
Ackman started buying when the price dropped to around $ 330. Looking at a chart from the start of the year, we see that it probably started buying around March 5, when the price was $ 330.24:
Domino’s price started falling in early October 2020, and it deepened when fourth quarter results came out on February 25. From there, it continued to slide until it hit a low of nearly $ 330.
Soon after, the price started to rise and it was nearly $ 100 higher at the close of trading on May 14th. Ackman’s purchases likely helped push the price up after March 5; when large funds buy, they have to buy in relatively large quantities.
However, the guru was not buying on price alone. He also likes the food court, saying, “Domino’s is a pure franchise business and interestingly, they were the first to invest in technology and delivery.” He also noted: “They own their delivery infrastructure and they don’t need to rely on the DoorDashes of the world.”
At the end of 2020, three of the seven stocks in its concentrated portfolio were in the restaurant business:
Founded in 1960, Domino’s now sees itself as the world’s largest pizza company based on global retail sales. It operates 17,600 stores in more than 90 markets around the world. Its business model starts with delivery, although it also attracts a significant portion of revenue from carry-over customers.
It is primarily a franchisor, with around 98% of its sites owned by independent franchisees. In his 10-K for 2020, he said that he generates his revenue and profits by charging royalties and fees to these franchisees.
Despite the difficulties posed by the Covid-19 pandemic, Domino’s increased its sales last year. In addition, it launched three new products (“New and Improved” Chicken Wings, Chicken Taco Pizza and Cheeseburger Pizza). Its digital channel also increased significantly last year, which is no surprise given the restrictions brought about by the pandemic.
Domino’s competes in the delivery and delivery segments of the larger pizza industry.
U.S. competitors include regional, local and national chains such as Pizza Hut (owned by YUM Brands (YUM, Finance)), Papa John’s (PZZA, Financial) and Little Caesars (owned by Ilitch Holdings Inc.). In addition, it competes with local pizzerias.
Internationally, it competes with Pizza Hut and Papa John’s, as well as national chains and local pizzerias.
The basis of competition includes product quality, location, image, service, technology, convenience, and price. He had a return on capital of 50.92% at the end of the first quarter of 2021, just over double that of Papa John’s (24.85%). This suggests that Domino’s is in a strong competitive position due to the strength of its brand.
The score is low, but on the other hand, Domino’s is a Buffett-Munger stock, and companies that pass this scanner must meet this criterion: “Companies that incur little debt while growing their business.”
It is also a company that has used borrowed funds since its inception. As noted in 10-K, “Since 1998, the company has been structured with a leveraged balance sheet and has completed a number of recapitalization transactions.”
As of December 31, the balance sheet contained these figures:
- Cash and cash equivalents: $ 169 million.
- Short-term debt: $ 39 million.
- Long-term debt and capital lease obligations: $ 4.318 billion.
The Piotroski F-Score and Altman Z-Score are adequate, showing that the management is doing a good job and that there is no risk of bankruptcy.
Most impressive in this table is the return on invested capital. It is 58.28% against 17.19% for Papa John’s. Domino’s also has the advantage on the weighted average cost of capital: 4.37% against 6.85%.
An excellent profitability score, but the GuruFocus system generates a serious warning about a drop in operating margin. A closer look shows that was true in 2018, but otherwise the numbers have risen:
The three growth lines, for turnover, EBITDA and earnings per share, are very good.
The pizza company has stuck enviable returns. We start with the annualized returns:
- Cumulative 2021: 11.68%
- One year: 14.51%
- Three years: 20.96%
- Five years: 29.21%
- 10 years: 34.19%
The total returns for the past five years have been:
- 2020: 30.53%
- 2019: 18.46%
- 2018: 31.24%
- 2017: 18.66%
- 2016: 43.14%
Dividend and share buyback
The total return shown above includes a dividend. And that dividend, per share, has grown rapidly over the past decade:
However, the strength of the dividend is not apparent due to the rising share price:
With a payout ratio of 27%, it is obviously possible to grow it. But can Domino’s afford to raise it? The answer comes from the amount of free cash flow available, and history suggests that it should be able to keep increasing the dividend:
Shareholders have also seen the value of their shares increase due to share buybacks:
This is a 10 year price chart:
The shares Ackman bought around $ 330 has already paid off him a lot.
Is it still possible to buy Dominoes and get a decent return? According to the GuruFocus Value Line, the stock is only slightly overvalued:
The PEG ratio, which provides a valuation against the backdrop of growing EBITDA, also suggests a modest overvaluation (1.76 vs. fair value of 1.00).
The discounted cash flow calculator, using profit power and based on a predictability estimate of four out of five stars, shows a margin of safety:
If you follow Ackman, however, the price may be too high; he said Pershing bought almost 6% of the Dominoes but wanted to buy more. He might not have bought more because he found the price too high to continue.
With the notable exception of Ackman and a few others, gurus sell more than buy:
Eight of the gurus own shares in Domino’s, and these three have the largest holdings:
Jim simons(Trades, Portfolio) ‘Renaissance Technologies held 936,425 shares at the end of the first quarter after reducing its stake by 22.92%. These shares represented 2.41% of the free float of Domino and 0.43% of the assets under management of Renaissance.
Ken fisher(Trades, Portfolio) of Fisher Asset Management also reduced its stake in the first quarter from 4.07% to 379,573 shares.
Pioneering investments(Trades, Portfolio) added 190.05% in the fourth quarter of 2020 and currently owns 109,796 shares.
When the next round of reports comes out, Ackman should have the biggest position; as he noted last week, he bought almost 6% of the outstanding shares.
Ackman and his hedge fund, Pershing Square, made a bold move by selling Starbucks and buying Domino’s Pizza. It could also be called a movement against the tide, as the gurus were selling more than they were buying back then.
Still, with the price rising $ 100 since he started buying in the $ 330 range, Ackman has done very well with his trade. It should see even more profits in the years to come, as Domino’s is a high quality company available at a fair price.
Despite the numbers, value investors will want to be cautious given Domino’s debt and low margin of safety. Growth investors who watch the price chart may see an opportunity, while income investors have reason to study both the dividend and the total return.
Disclaimer: I do not own any shares in any of the companies listed in this article and do not plan to purchase any within the next 72 hours.
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