Domino's Pizza (DPZ) releases its Q1 results on Monday, April 29, before the market opens. DPZ stock looks cheap now based on forecasts, price targets, additional buybacks, and its recent 25% dividend hike. OTM put premiums are high, and worth shorting for income investors.
DPZ stock is trading at about $478, up about 1.4% today, April 23. It's down from a recent peak of $506.34 on April 10.
Moreover, on Feb. 26, Domino's announced a dividend per share (DPS) of $1.51 per quarter ($6.04 annually), up 25% from $1.21 ($4.84 annually) in the prior quarter. It also announced a $1 billion hike in its share buyback program.
Higher Price Targets
All of this adds up to a higher price target for DPZ stock by many analysts. For example, Yahoo! Finance says the average of 28 analysts' price targets is $504.93, or +5.1% from today's price. But AnaChart, a new sell-side analyst tracking service, reports that 33 analysts have an average price target of $522.01, +8.67%.
However, DPZ could likely rise much further based on its historical dividend yield. For example, Seeking Alpha reports that the stock has an average dividend yield of 1.0% in the last 4 years, and even 0.60% in the past 5 years.
Today, its yield is 1.26% (i.e., $6.04 DPS/$478 price per share).
That implies that DPZ stock could rise to $604 per share, or 26.3% higher. Here is why.
If we take the $6.04 DPS and divide it by the 4-year average 1.0% historical yield, the price target is $604 per share. Moreover, using the 5-year 0.60% average yield, the price target would be over $1,000 per share (i.e., $6.04/0.006 = $1,006.67).
The point is that the recent 25% dividend hike has not yet been fully absorbed into the stock price, in terms of its historical yield. DPZ stock is worth at least 25% more. On top of this, the company's free cash flow (FCF) implies a higher price target as well.
FCF Supports a Higher Price Target
For example, last quarter Domino's Pizza reported that its FCF rose 25.1% in 2023 to $485 million over 2022's $388.1 million. Moreover, its FCF margin jumped from 8.55% in 2022 to 10.8% in 2023. This was despite a 1.3% decline in sales in the same period. So, the company is wringing out more cash from its operations.
However, during Q4 the company's FCF margin was lower at 8.7% (i.e., $122.6 million FCF/$1.4 billion in sales). So, if we use an average FCF margin of just 10% for 2024 the stock is still worth more.
For example, based on analysts' estimates of $4.81 billion in sales, the company could generate $481 million in FCF this year, about level with last year. But if it continues to make 10.8% margins that figure rises to $520 million. Moreover, by 2025, analysts forecast $5.14 billion in sales, or 6.86% more. That raises the potential FCF estimate to $462.6 million.
These FCF projections lead to a much higher stock market valuation. For example, using a 2.5% FCF yield metric, Domino's Pizza would be worth $20.8 billion (i.e., $520m FCF / 0.025). That is 24.5% over its present market cap of $16.7 billion. In other words, DPZ stock price could rise by 24.5% to almost $600 (i.e., 1.245 x $480.35 = $598.00 per share).
The bottom line is that DPZ stock looks cheap here, both on a dividend yield historical metric basis and also using FCF yield metrics. If the company reports strong FCF results on Monday, DPZ stock could eventually move significantly higher.
One way to play this is to sell short out-of-the-money (OTM) put options in nearby expiry periods.
Shorting OTM Puts
For example, look at the May 17 expiration period, which is less than 4 weeks away (24 days). It shows that the $460 strike price puts trade for $8.20 on the bid side. That provides a potential 1.78% yield for the short-put investor with a strike price that is over 4.2% below today's price.
In addition, a closer put strike price, which entails more assignment risk, at the $470 strike price trades for $11.50, or a put yield of 2.45% for an investor who sells these put options short. However, the out-of-the-money width is lower at just 2.14%.
Essentially any investor shorting these puts must be willing to potentially buy the stock at a lower price. They can generate some extra income by doing this. That helps increase their dividend yield and also provides a good entry point.
I have shown that this is a good risk to take, given that DPZ stock looks undervalued here. The company's Q1 earnings and FCF results on Monday may vindicate this.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
