DPZ – Cash is King

I wrote a post about DPZ titled “Follow the Cash” back in July and despite the company’s disappointing 3Q results reported today (particularly from a top-line perspective), DPZ’s business continues to yield ample free cash flow. Year-to-date, DPZ has generated $25.8 million in free cash flow, and that number would be closer to $44 million, excluding two non-recurring expenses.

Although the company’s balance sheet is significantly leveraged (debt/LTM EBITDA over 7x), DPZ’s business model will allow it to meet its interest payments and/or pay down debt over time. I am even more confident in DPZ’s ability to pay down debt following management’s comments today on its earnings call about its plans to build cash reserves. “We are going to pile up more cash than we would think about piling up until the situation sorts itself out and once we know where the credit markets are, where our revolver is as we see more trends develop in terms of what's happening with the health and vitality of our franchise system, we would make a better decision as it relates to stock repurchase at some point in the future. So right now we are going to carry a larger cash balance and see how this all sorts out.”

In argued back in July that DPZ should not buy back stock, so needled to say I would agree with management that buying back stock might not be the most prudent use of cash right now.
  • Management voiced a lot of concern about the credit markets and the impact tightened credit markets are having on its franchisees, particularly as franchisees experience lower EBITDA margins (management expects 2008 franchisee EBITDA margins to be worse than the already low margins in 2007). The current credit conditions are making it increasingly more difficult for financially stable franchisees to acquire underperforming stores or for underperforming stores to get the short-term financial support they need to turn around their businesses.

  • DPZ currently working with banks and other lending institutions to get deals done, but they went on to say they will provide financial support if need be. “It will never be my preference to provide financing to our franchisees. We would rather keep our relationship with them being the franchisor rather than their bank. However we are weighing through unchartered waters and we are not going to let our A and B franchises fail if there are ways we can be helpful with some short term financial support and solution.”
  • The company said that one way it could offer financial support is by providing some deferral of costs and/or royalty payments. One primary benefit of the franchisor/franchisee business model is that it allows a franchisor to grow without bearing as much financial risk. By providing short-term financing to its franchisees, DPZ will be increasing its financial risk and heading down a potentially slippery slope.

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