Domino’s Pizza Ready to Be Sliced

Click to Enlarge Talk about a recipe for success. Take a bad product and make
it average, launch a brilliant marketing campaign to support the change, then
watch your stock soar to an all-time high. It's not the traditional route to
riches, but it has certainly worked for Domino's Pizza (NYSE: DPZ ). The stock
closed at $33.42 on Thursday, up from $15.95 at the start of the year and $2.61
in late 2008. It's been an outstanding turnaround story, but it's time to
start betting against Domino's. Here are four reasons that the best days for
DPZ stock are likely behind it: Valuation Domino's is trading at 22.2 times
trailing earnings, just short of its five-year high of 23.4 (hit in March, 2007)
and well above its five-year average of 13.4. The forward P/E, at 17.7, also is
rich. Comparatively, Papa John's International (NASDAQ: PZZA ) trades at 14.6
times forward earnings. Other metrics: Domino's PEG ratio has hit an all-time
high, and its earnings yield, at 4.76%, is well below the five-year average of
9.3%. Price-to-sales paints the same picture: 1.25 now versus a five-year
average of 0.65. Valuation alone doesn't break a story, but this indicates
that the margin for error has narrowed considerably. Debt Domino's has a
ridiculous $1.45 billion of debt, versus cash of $78.6 million and a market cap
of a little around $2 billion. Operating cash flow in the trailing 12-month
period was $123 million, indicating the burdensome nature of the current debt
load and the potential for higher rates to damage this company down the road.
Insider Selling According to data on Yahoo! Finance , insiders have dumped 2.6
million DPZ shares in the past six months, which is a full 22% of the 9.2
million insider shares held. And keep in mind that with the stock having risen
so much already this year, the majority of these sales were executed at lower
prices than the level where DPZ is trading now not exactly a vote of
confidence. Institutions also have been lightening their position in the past
six months. Technicals Earlier this week, Domino's shares rose to their
all-time high just above $35, then pulled back. With the stock up more than 105%
so far this year, there appears to be more potential for a double top than a
sustainable breakout. Domino's stock still has some positive trends working in
its favor. The admission that its pizza was subpar has been an
attention-grabbing gambit that has helped drive business, although the quality
of the new recipe remains up for debate. The company's web initiatives also
have boosted growth, as evidenced by its first week of more than a million
combined orders from the web and mobile devices in the week ended Nov. 4. Other
factors supporting the stock have been the company's ability to withstand a
slow-growth environment, its short interest (at about four days to cover), and a
recent positive mention by Jim Cramer on Mad Money . But for all the hype about
Domino's turnaround story, sales growth is projected to come in at just 5.8%
year-over-year in 2011 and 3.5% next year. On balance, consider the stock a
better short than a buy at this level. Daniel Putnam was long puts on DPZ.