Domino’s Pizza (DPZ) – updated writeup, and conclusion
Our last updated writeup on DPZ was on 10/5/18 with the stock at $281, and our conclusion was “We wouldn’t want to be short this fine company’s stock, and DPZ has been a fantastic holding over the last decade, but we have a feeling that “the easy money has been made”.
Today, nine months later, worth 9-10% in terms of valuation relative to annual EPS growth (12%-14%), and combined with the 10% lower stock price, DPZ is valued about 20% less, relative to the fundamentals, than at 10/5/18. Affected, to be sure, as they are in the short term by the competitive effect of the new delivery aggregators, we believe that is now adequately reflected in the stock price. We believe that Domino’s is positioned as well, or better, than the other major restaurant brands, is valued no higher (and sometimes less), and therefore suggest that an opportunity exists for long term investors.
COMPANY OVERVIEW (Per July 2019 Investor Presentation)
Domino’s, with more than 16,314 locations, as of 6/30/19, in over 85 countries around the world, is the largest pizza company in the world based on global retail sales. Founded in 1960, Domino’s roots are in pizza delivery. In recent years, however, a significant amount of sales have come from carryout. On average, Domino’s sells more than 2.5 million pizzas each day. Domino’s business model is simple – they handcraft and serve quality food at a competitive price with easy ordering access and efficient service enhanced by their technological innovations.
Domino’s generates revenue and earnings by charging royalties and fees to their franchisees, 5.5% of sales domestically and 3% internationally. The Company also generates revenue by selling food equipment and supplies to franchisees, primarily in the U.S. and Canada, and by operating a number of Company owned stores. In Domino’s international markets, they generally grant master franchises for a geographic area. These master franchises are charged with developing their geographical area and they may profit by sub-franchising and selling food and equipment to these sub-franchisees as well as by running their own stores. Domino’s pioneered the pizza delivery business and has become one of the most widely recognized consumer brands in the world.
Domino’s business model yields strong returns for their franchise owners and Company owned stores. Historically, Domino’s has returned cash to their shareholders through dividend payments and share repurchases.
LONG-TERM BUSINESS STRATEGY (Per July 2019 Presentation and 2018 10K)
Begun in 2009, Domino’s first priority was to reinvent their core pizza, and they relaunched the brand by introducing a new recipe for their signature product. Next, they improved existing products and/or introduced new items that complimented changes to the core pizza.
Secondly, in 2013 they launched the program to reimage the stores to be more attractive for carryout customers – creating the “Pizza Theater” design which allowed customers to see the process of pizza making. This has been an effort to respond to market studies (from NPD/Crest) that indicates that the take-out business is much bigger than delivery. In 2017, delivery business equaled over 1 billion occasions whereas carryout was over 2.5 billion occasions. Since Domino’s carryout focus was launched in QTR-1 2011, by Q1’18, Domino’s share of carryout had risen from 7.5% to 14.4%. However, since carryout necessitates Domino’s to be closer to the customers, the Pizza Theater remodel was introduced in 2013 to make carryout more convenient. By the end of 2018 the majority of US and international stores had completed this remodel. Also emphasized, starting several years ago, was a realignment of the US franchise system (called the Fortress program) into more concentrated multi-unit operating hands. Since 2016, Domino’s U.S. franchise base count has contracted from 1,300 to about 800 owners. This new alignment continues to drive growth with multi-unit franchisees who share the corporate vision
Thirdly, a priority continues to be an aggressive investment in technology (which began in 2010) to be the leader in making connections with consumers through technology that exceeded their expectations. This became an aggressive investment in building digital platforms and eventually data analytics in-house. In 2016 Domino’s developed its own digital platform to manage internal operations and customer-facing actions all with the goal to simplify ordering and payment processing and enable order tracking on virtually any communication device. The system is called GOLO (Global Online Ordering). Together with a sophisticated loyalty program (launched in 2016), the platform provides a rich source of data for its robust marketing initiatives.
SOURCES OF REVENUE (per 2018 10K)
As of its 2018 10-K Report, Domino’s operated and franchised 15,914 units globally generating more than $11 billion, making them the largest pizza chain in the world, based on global retail sales, as well as the number one pizza delivery company. Approximately one-half (49%) of the global sales are generated by 5,876 domestic stores (5,486 franchise and 390 Company). The remainder (51%) is produced by 10038 franchised stores in over 85 markets around the world. Additionally, $1.94 billion was generated from Domino’s supply chain.
The following table provides summary financial statistics over the five years ending 12/31/18.
Domino’s revenue, as shown above, is generated from multiple sources: domestic franchise fees (5.5% of franchisee sales), international master franchise fees (3.0%), domestic and GOLO digital fees, and supply chain and Company-owned store segment.
UNIT LEVEL ECONOMICS (Per July 2019 Investor Presentation and 2018 10K)
From the FDD and the above sources, we estimate AUV’s of Company units are about $1.25M $1.25M (or about $833/sq. ft. assuming the average store size of 1,500 sq. ft.) and domestic franchised units AUV’s are about $1.05M. Disclosed average store level EBITDA of domestic franchisees is about $141K – up from $61K in 2009 or a store level EBITDA margin of 13.4%. (These figures are presumably net of royalty fees and advertising fund contributions.) The cash investment for leasehold improvements, furniture, fixtures, equipment, signage for a new store (provided from Domino’s 2017 Franchise Disclosure Document) is about $410K. Accordingly, the $141K store level EBITDA would represent a store level cash on cash return of 34.3% for a domestic franchised unit.
The supply chain provides pricing and distribution scale and consistent uniform quality ingredients to participants. It operates 18 regional dough manufacturing and food supply chain centers in the U.S. It also operates centers in Canada and leases a fleet of more than 500 tractors & trailers.
SHAREHOLDER RETURN (Per 2019 Investor Presentation)
Since 1998 the Company has been structured with a leveraged balance sheet and has completed a number of recapitalization events. The Company’s most recent recapitalization transaction (in 2018 and early 2019) primarily consisted of the issuance in 2018 of $825M at a blended rate of 4.2% and the repurchase of about $600 million of common shares, after repurchasing $1.06B worth in 2017. Remaining on the stock repurchase authorization is $150M. Following the most recent recap activities, the Company has about $3.5 billion in total debt, which is approximately 5.8x trailing EBITDA.
While DPZ has been in a “trading range” over the last twelve months, the long term stock performance has been outstanding, one of the very best within the restaurant industry. There is a common stock dividend that amounts to a current yield of about 1%.
RECENT DEVELOPMENTS (PER Q2’19 EARNINGS REPORT AND CONFERENCE CALL)
While same store sales were several points less than analysts expected, and up at lower rate than in recent history (as you can see from the table above, Domino’s basically continued its outstanding performance in Q2’19, with domestic same store sales up 3.0%, international up 2.4%. It was the 100thh consecutive quarter of int’l SSS growth, only the 31st domestically. Diluted EPS was up 23% on a GAAP basis and 19% “adjusted”. Income from operations (pretax) was up a more modest 10.3%, income before taxes, after lower interest, was up 16.2%, net income, after a lower tax rate, was up 19.3%, and EPS, with fewer shares outstanding, was up 23.0%. There were 200 net new stores added to the system, 158 internationally and 42 domestically.
The Conference Call provided some additional operating details.
While both US sales and international sales were up, it was driven by ticket growth and the comparison against strong sales in ’18. The global total retail sales growth of 5.1% would have been 8.4%, adjusted for the strong US dollar. Management emphasized on the conference call the effect of new competing delivery aggregators (Doordash, UberEats, etc.) who are advertising aggressively as they fight for market share. Management does not expect any near term reduction in this competitive incursion. On the positive side, net new unit growth continued strong with 200 net new openings. The company continues to invest in technology, with $110-120M to be spent in ’19, similar to ’18. Still, the first half of ‘19, after capex, generated over $175M of free cash flow. A new GPS tracking program will be introduced by the end of ’19 and an experimental pilot program, in Houston this fall, will test self driving delivery vehicles. A heavy emphasis continues to be made with the Points for Pies loyalty program.
Though the most recent couple of quarters have been at the low end of long term guidance, especially for same store sales growth, management reiterated their 3-5 year outlook for growth in global net units of 6-8%, US and Int’l SSS growth of 3-6%, and total Global Retail Sales growth of 8-12%.
CONCLUSION: Provided at the beginning of this article.