Domino's Pizza Delivers Strong FCF and FCF Margins - Is DPZ Stock Too Cheap?

Domino's Pizza (DPZ) delivered higher-than-expected Q2 revenue growth. Its free cash flow (FCF), although slightly lower than last year, was much higher than last quarter, with higher margins. Value investors think DPZ looks cheap here, with a $413 price target (+25.6%), $based on its strong FCF and FCF margins.

DPZ closed at $328.97, up 2.1%, and has begun recovering from a recent trough price of $283.03 on June 23. However, it's still well below a March 9 peak of $415.78. 

My analysis shows that DPZ could be worth significantly more, over 25% higher, especially if Domino's keeps generating strong FCF. This article will show why.

Strong Revenue and FCF Margins

Domino's makes pizza dough and supplies it along with equipment to its franchised and own stores. CNBC pointed out that in Q2, although consumers have cut back on purchases, its supply-chain business's price increases and higher order volume led to higher-than-expected revenue growth.

For example, its Q2 sales were up +4.30% at $1.19 billion vs last year's +4.32% Q2 growth rate. However, this was higher than the +3.5% growth rate in Q1. Moreover, its first-half (H1) revenue was up +3.88% vs. last year's +3.425% growth rate (according to data from Stock Analysis).

In addition, analysts had been expecting $15.12 million lower Q2 revenue, so it beat expectations by 1.29%. Given the razor-thin margins it generates, every bit counts.

For example, free cash flow (FCF) came in strong at 14% of revenue (i.e., $166.68 million/$1.19 billion), according to Stock Analysis. However, H1 was 5.5% lower than last year, according to the earnings release, due to high capex. Nevertheless, its trailing 12-month (TTM) FCF was up 6.57% YoY.

Moreover, its TTM FCF margin has stayed strong at 13.0% of revenue in Q1 over the past year (see Stock Analysis data). That compares with 12.82% a year ago, and 13.12% in Q1.

This means analysts can project strong FCF over the next year.

Projecting FCF and Fair Market Value (FMV)

For example, analysts now project 2026 sales of $5.2 billion and $5.37 billion next year. That implies a next 12-month (NTM) forecast of $5.285 billion.

So, using a 13.0% average FCF margin, FCF could reach $687 million. As a result, using an average 5% FCF yield metric (i.e., 20x FCF), the fair market value (FMV) is:

  $687m NTM FCF x 20 = $13.74 billion FMV

That's 25.6% above the $10.94 billion market value today, according to Yahoo! Finance's capitalization number.

In other words, DPZ's price target (PT), based on its FCF forecasts, is 25.6% higher:

  $328.97 x 1.256 = $413.19 price target (PT)

Other analysts agree. Yahoo! Finance reports that 30 analysts have an average PT of $390.86, and Barchart's PT survey is $391.57. 

Moreover, 22 analysts surveyed by AnaChart have an average PT of $422.16. AnaChart tends to be more precise, as it counts more recent analyst writeups over the past year and drops out-of-date or dropped coverage PTs.

The bottom line is that DPZ stock looks attractive to value investors as its stock price looks too cheap here.

However, there is no guarantee it will rise. It could stay in a trading range or drop. As a result, one way to play it is to sell short out-of-the-money (OTM) puts.

Shorting OTM DPZ Puts

This way, an investor can earn monthly income while also setting a potentially lower buy-in price. For example, the August 21 expiry period shows that the $300.00 strike price put option has a midpoint premium of $4.25.

That implies that a short-seller of this contract can make a one-month yield of 1.4167% (i.e., $4.25/$300.00).

This occurs when an investor who posts $30,000 with their brokerage firm can then enter an order to “Sell to Open” 1 put at $300. The account will then immediately receive $425. That represents about 1.42% for the month.

However, less risk-averse investors can short the $310 strike price put and make $6.50, or 2.1%. Even if DPZ drops 5.77% to $310, the investor has a breakeven point of $303.50. That's 7.74% below Monday's close.

If an investor can repeat this play every month for 6 months, the expected return is 12.6% and 25.2%. That is almost equal to the 25.6% expected return holding DPZ, as I showed above.

This shows that it makes sense for value investors to short out-of-the-money (OTM) puts to both gain extra income and potentially set a lower buy-in price.