The great thing about restaurant stocks is that if a chain is successful in one region, chances are it can repeat that success in new cities and areas as well.
There are a number of restaurant and food service companies listed on the ASX. Probably the best known and most successful is Domino's Pizza Enterprises Ltd. (ASX: DMP). Being a pizza lover, I don't really need a lot of reasons to like the restaurant, but I have three reasons why you may want to have this fast grower in your portfolio.
1) Track record of strong growth
Before 2014, the stock was already a big gainer. Even though many Australians regularly ordered the takeaway pizza, probably most of them didn't notice the share price climbing from about $3 in mid-2009 to $12 in 2013 – a four-bagger during the GFC recovery!
Since then it has more than doubled to around $25.50 thanks partly to the continued domestic expansion, but more so because of its acquisition of a 75% stake in Domino's Pizza Japan.
FY 2014 saw revenue almost double and full year net profit was up 50.4%. Australian store numbers now total over 600, store expansion in several European countries is doing ok and about 50 new stores in Japan have been added since the September 2013 acquisition.
2) Explosive growth in Japan
For growing restaurant chains, investors can make their best returns by being near the start of the expansion phase once the business has established itself. You may have missed the Australian growth over the past 4 – 5 years if you didn't buy shares already, but now you may have a chance with the Japan growth story.
The company's goal is to become the largest takeaway pizza chain in Japan. Last year it was number three and now it is already number two. Initially, the company projected it could grow the chain there to about 600 stores from the original 250 over five years. Now, after more market research, its projections are for 600 – 800 stores. It plans to open about 60 stores in FY 2015, entering new cities and regions to hit its targets.
3) High rate of forecast earnings
This could send the company's group revenue up at a heated rate, which is why the stock has a 44 price-to-earnings ratio. The expectation of high earnings growth has pushed the stock up so much that investors may now feel afraid to buy stock.
Analysts forecast around an average 23% earnings growth annually over the next two years, but remember the Japan expansion may take up to five. I would be happier to see the PE around 30 for that kind of growth, but on next year's earnings estimate, that would still need the stock to come down to $19.30, or a 24% decline.
If we have a severe correction, then it could be a great buy, but I would be hesitant to buy it after such a strong run-up in share price.
Although I really like the company's growth prospects, I would hold off on recommending it until some of the heat comes out of the price. There are other stocks that could give you decent growth and a good dividend yield for a better price.
