It’s time to discuss a company I’ve never covered before. It’s also a company that doesn’t necessarily fit my strategy, as I tend to avoid companies in low-barrier industries.
In this case, I’m talking about Domino’s Pizza (NYSE:DPZ), the world’s largest quick-service pizza restaurant.
I’m writing this article because of two reasons:
- It’s time I discuss a company that has not only crushed the market over the past two decades but also beaten high-flying tech stocks. Now, the company has been going sideways since 2020, as rising inflation is doing a number on consumers. Getting insights into the company’s impressive business model and the state of the consumer is always interesting – and important.
- Not only is DPZ an impressive performer. It also has a history of aggressive dividend growth and buybacks that are likely to continue, thanks to the company’s ability to innovate and grow in a very competitive market.
So, without further ado, let’s get to it!
The DPZ Business Model
I’ve had Domino’s Pizza plenty of times. I cannot say that I prefer it over traditional Italian pizza. However, its business model is genius. Just like McDonald’s (MCD), Domino’s has become a place where people know exactly what they can expect in terms of service and quality. It’s also extremely convenient.
When it comes to the value it brings to the table, the company aims for a straightforward model where a wide variety of customers find food items they desire at decent prices.
Going into this year, the company had more than 19,800 locations in 90 markets.
Domino’s operates primarily in the domains of delivery and carryout, and interestingly, it mainly functions as a franchisor, as almost 99% of Domino’s global outlets are owned and operated by independent franchisees, which shows just how attractive the DPZ franchise model is.
Also, because of this, the company makes most of its money from its Supply Chain segment. This is the segment where the company sells ingredients to franchise stores.
|USD in Million||2021||Weight||2022||Weight|
|2,700||62.0 %||2,898||63.9 %|
|1,498||34.4 %||1,487||32.8 %|
|298||6.8 %||295||6.5 %|
|-139||-3.2 %||-143||-3.2 %|
Having said that, the global pizza industry is estimated to be roughly $120 billion. More than $80 billion comes from QSR restaurants. The U.S. dominates half of that market.
The four largest chains in the U.S. dominate 52% of that market, which shows just how fragmented this industry is. After all, entry barriers are low. Everyone can make a pizza.
Selling it to the masses without losing money is where it becomes tricky.
Hence, in addition to offering food at attractive prices with quick service, Domino’s has made it its goal to become even more convenient.
As the market leader in pizza delivery in the U.S., Domino’s boasts approximately 32% share of delivery dollars and around 19% share of carryout/drive-thru QSR pizza consumer spending.
To grow its footprint in this area, the company has become tech-focused.
Digital channels have become key, contributing to nearly two-thirds of global retail sales.
The company has also developed diverse ordering platforms, incorporating GPS-enabled tracking systems, and introduced a comprehensive loyalty program, Piece of the Pie Rewards, aimed at enhancing customer engagement and experience.
Especially in this economic environment, loyalty programs aim to maintain good consumer relationships.
Even better, Domino’s technology is based on three pillars:
Predictive Insights: Utilizing advanced analytics and machine learning, Domino’s taps into historical sales data to accurately forecast product demand. This allows the company to manage inventory efficiently, minimizing wastage while meeting high-demand periods.
Tailored Engagement: Through comprehensive customer analysis, Domino’s segments its customers based on past orders and preferences. This segmentation enables personalized marketing efforts and bespoke promotions, enhancing customer loyalty and satisfaction.
Digital Advancements: At the forefront of digital transformation in the food industry, Domino’s has innovatively crafted its ordering app, streamlining the pizza ordering process for users across various devices. Additionally, the app incorporates a real-time GPS tracking system for customers to monitor their orders.
While I do not have the data to back up that Domino’s food is better, it does have technology solutions that enhance its margins and allow it to offer an even better customer experience.
Taking Things To The Next Level
Domino’s is, without a doubt, one of the best-performing companies over the past two decades. However, since 2020, its stock price has gone sideways after peaking in 4Q21.
Like many other companies, the pandemic resulted in too many investors betting too much money on a new restaurant environment. When the pandemic ended, inflation soared, and investors rotated money back into non-pandemic stocks. Too much growth was priced in over the past few years.
The good news is that while net income has slowed, the company remains in a terrific position – even in light of elevated inflation.
During the second-quarter earnings call, the company provided insights into pricing strategies, revealing a 3.9% average price increase across the U.S. system in 2Q23.
The company projected a similar trend for 3Q23 before a moderation to approximately 2% in the fourth quarter.
Domino’s also acknowledged the challenges in the U.S. delivery business, with the second quarter witnessing a decline in same-store sales of 3.5%.
However, the carryout business remained robust, posting a strong same-store sales growth of 5.6%.
Furthermore, the company covered its global retail sales growth outlook, aiming to track between the low end and midpoint of its two to three-year outlook of 4% to 8%.
Having that said, analysts expect the company to see a significant rebound in growth. 2022 was a very poor (post-pandemic) year. 2023 is expected to be better. 2024 and 2025 are expected to see 9% growth again.
While I just gave some 2Q23 numbers, the real highlight of the second-quarter earnings call was the company’s plans to capture additional growth.
For example, a significant highlight was the recently announced partnership with Uber Eats, which is expected to significantly expand Domino’s delivery customer base.
The company made the case that the entry into the aggregator marketplace, catering to nearly $5 billion in sales for delivery among U.S. quick-serve pizza restaurants, presents a substantial opportunity.
The move is projected to bring in over $1 billion in incremental sales for Domino’s U.S. business.
The company is also working on a bigger share of the carryout market.
Despite this impressive growth, our current aspiration is to drive our carryout market share even further to at least the same market share we enjoy in pizza delivery today. We need to earn an additional 10 points of market share to reach our fair share in the carryout segment, and this 10 points represents about $2 billion in additional retail sales. – DPZ 2Q23 Earnings Call
During this month’s Piper Sandler Growth Frontiers Conference, the company elaborated on these plans.
During the conference, Joseph Jordan, the President of the U.S. business at Domino’s, provided a detailed overview of Domino’s new rewards program.
The program, initially launched in 2015, aimed to stimulate incremental orders by increasing loyalty and driving the growth of the company’s carryout business.
However, through years of analyzing customer interactions and feedback, Domino’s realized the need for evolution to improve engagement, especially for customers with fewer occasions.
Key changes in the program include lowering the earned threshold from $10 to $5, adjusting burn redemptions, and allowing for more personalized incentives.
This revamped program is expected to encourage both carryout and delivery business, enticing customers with points for purchases, ultimately leading to increased engagement and more frequent transactions.
While I’m not a QSR professional, this move makes sense to me, as we’re now in an environment where consumers are watching every penny. It needs to be easier to enter certain reward programs, not harder. It’s also a very low-cost way to get customers to be more engaged.
Having said that, the company is NOT focused on hiking prices at all costs. Its goal is to thrive based on volumes, and I believe its actions and growth measures clearly reflect that.
And then, with pricing, to me, the pricing at Domino’s has always been volume-based. We certainly want to have — on an order-by-order basis, we want to make sure our franchisees are making the profit they need to, and Sandeep talked to the increase in franchisee profitability. But then, once the profit per order is established, we have, what we call, a high-volume mentality. And so, we price for proper profitability on a per order basis that will help drive consumer to buy Domino’s more frequently. And so that’s kind of how we look at it. I don’t expect to be at the high end of pricing. What I expect to do — and I think if you look at other restaurants in our categories, I expect our franchisees to be at the high end of profitability, while we’re offering best-in-class value to customers. – DPZ 2Q23 Earnings Call
While this environment is certainly bad for companies catering to everyday consumers instead of high-end customers, this strategy will likely maintain great customer relationships, positioning the company for faster growth once we’re in a lower-inflation environment – whenever that may be.
Looking at analyst estimates, we see an expected recovery in margins to more than 20% by 2025E.
The company also remains in a great spot to reward investors.
The DPZ Dividend
Domino’s has a history of significant shareholder distribution growth. The company, which is expected to end this year with a 5.4x net leverage ratio, has a dividend yield of 1.3%.
This is nothing to write home about. However, it’s backed by a 35% payout ratio and a 33% 2024E cash payout ratio, using expected free cash flow (as seen in the overview below).
Over the past five years, the average annual dividend growth rate was 17.5%.
On February 23, the company hiked by 10%.
It has hiked its dividend for nine consecutive years.
Over the past ten years alone, DPZ has bought back 37% of its shares. This has significantly added to its impressive stock price performance.
Going forward, I have little doubt that dividend growth and buybacks will remain elevated.
This is a bit of an issue. Domino’s isn’t insanely overvalued, but it also doesn’t offer the value I would like to see in an economy that could very well suffer from prolonged sticky inflation.
Over the past ten years, shareholders have benefitted from rising EBITDA (and earnings) on top of a rising valuation multiple. The longer-term median valuation is roughly 20x EBITDA.
Assuming that EBITDA is now growing roughly 300 basis points slower compared to pre-pandemic levels, I believe that an 18x multiple is appropriate. This gives the stock a fair value of $403 per share.
This implies that my target is 6% above the current price.
The current consensus price target is $418.
On September 5, TD Cowen came out, making the case for a potential upside to $500.
As reported by Seeking Alpha:
The firm bumped the pizza maker’s rating to Outperform from Market Perform, forecasting “the enticing 2024-25 U.S. sales narrative from the Uber partnership & self- help initiatives will drive positive sales revisions & organic EPS beats.”
TD Cowen’s valuation suggests favorable risk/reward of $343 downside/$500 upside.
“We are encouraged by the soon-to-be launched playbook to ignite Domino’s U.S. delivery turnaround balanced between the Uber partnership,” TD Cowen analysts led by Andrew M. Charles wrote in a note.
Also playing in DPZ’s favor are a loyalty program that is getting a refresh this month, a more frequent cadence of menu innovation and a revamped e-commerce platform.
I agree with the bank. After all, we spent an entire article discussing the company’s many tailwinds.
However, given my view on the economy, I need a better price before making the case that DPZ is a must-own stock.
What I will do is put DPZ on my watchlist. If the market offers us more weakness, I think the stock would be a great buy, close to $300-$320.
In analyzing Domino’s Pizza, it’s clear that this global QSR giant has successfully navigated the volatile market and changing consumer landscapes.
The company’s innovative business model, rooted in convenience and bolstered by advanced technology, positions it as a strong consumer stock capable of aggressive growth.
DPZ also has a history of rewarding shareholders through dividends and buybacks, which has boosted its total return tremendously.
While the present valuation may not be ideal, keeping a keen eye on potential market dips and aiming for an entry price around $300-$320 could offer a favorable risk/reward ratio for potential investors.