3 Reasons Why Domino’s Will Continue to Make Investors Dough
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The quick serve restaurant space has increasingly become one of the most dynamic segments in the consumer retail market. The relatively prolonged stagnation in the mature domestic market has begun to ease, and quick serve choices like Domino’s (NYSE: DPZ), McDonald’s (NYSE: MCD), and Yum! Brands (NYSE: YUM), largely though their expansion of healthier menu items, have enjoyed growth via a deeper penetration of the American market. Likewise, more consumer conveniences – in-store WiFi, 24/7 drive-thru windows, and online ordering systems – are making quick serve players an increasingly attractive option for those consumers who have traditionally stayed away from fast food joints. Lastly, many of the world’s fastest growing markets, which continue to be characterized by a heightened consumer willingness and ability to enjoy American quick serve food options, are leading way for unprecedented growth opportunities in the international market.
Although there are undoubtedly several routes towards taking advantage of the opportunity that is present in the quick serve restaurant space, there are several key reasons why Domino’s Pizza stands out among the competition – especially after its 11% price drop following its Q1 2012 results announcement.
- International Growth
The most successful of quick serve restaurants not only have the ability to adapt to the unique tastes of local consumers, but they also have the ability to maintain a consistent restaurant experience as the international store rollout progresses. There is probably no better example of the success that can be reaped from such a competency than McDonald’s historical growth experience, yet Domino’s has proven that it is no slouch when it comes to customer experience.
Like McDonald’s, Domino’s has capitalized on an extremely strong franchise platform, which presents the opportunity for swift growth while insulating the parent corporation from some of the risks inherent in buying property and operating restaurants in the international sector. Currently, franchise royalties drive more than 90% of Domino’s international operating profits, and the strong comparable store sales the corporation has enjoyed alongside its swift international growth exemplifies its ability to maintain a desirable consumer experience.
Store Growth represents year-over-year percentage growth in total international store footprint
The strong same-store sales performance in the international space has been maintained while adding 62% and 230% more locations than Pizza Hut and Papa John’s (NASDAQ: PZZA), respectively, over the same time period. With a proven franchise platform for international growth, as well as a relatively low penetration in key international markets, Domino’s will undoubtedly continue to enjoy a prolonged period of success outside of its core domestic market.
- Willingness to Pay
Domino’s has proven its ability to drive positive comparable store sales performance and continue to drive top line revenues with relatively little internal investment through the horizontal expansion of its core menu. New items including the Artisan Pizza line, pasta bowls, and sandwiches have become so successful because they not only attract consumers who traditionally did not spend money at Domino’s, but they also supplement the corporation’s menu with higher margin options because the items command higher purchase prices while using relatively similar raw materials as the core pizza menu items.
Such an ability to charge more for the same level of input labor and raw materials has given way to a higher level of profitability, even if general input prices for dairy, pork/beef, and grains are continuing to increase. Domino’s domestic company owned stores, for example, have grown gross margins by more than 400 basis points over the past four years – some of which can be attributed to the ability to pass on higher input costs to consumers.
- Huge Efficiency Gain Opportunities
One of the most influential drivers behind Domino’s future success is the opportunity that lies in the gaining of efficiency points. Many quick serve restaurants are currently toying with new ideas to drive in-store efficiency – McDonald’s and Chipotle have, for example, integrated touch-screen ordering systems or handheld ordering machines for employees to reduce queue times – yet Domino’s has one of the most unique and often overlooked technologies in its arsenal with its online ordering tool.
The corporation’s CEO makes it clear that nearly 1/3 of its domestic orders are now driven in the digital space – either through online or mobile app consumer ordering – and it is reasonable to assume that as awareness of both Domino’s and the digital ordering tool increase, the corporation’s worldwide footprint of stores will only become increasingly efficient. Such an ordering system, which allows consumers to fully customize different menu items for in-store pick-up or at-home delivery, not only reduces the total number of employees that Domino’s needs to operate each store, however. The system also acts to enhance the consumer experience by minimizing employee error and making the ordering process, well, fun. Consumers who use the tool have full reign on the design of their individual orders, and are presented with an order fulfillment chart that shows up-to-minute progress of their purchases (the so-called “pizza tracker”). The tool has become such a hit that a quick Internet search will yield several case examples of the fun that consumers have had with customizing orders to their exact specifications.
With an increasing number of competitive players within the quick serve restaurant space – especially the highly fragmented pizza market – such a convenience-boosting tool will continue to differentiate Domino’s and build consumer loyalty as the digital ordering system expands in the international market.
Is Domino’s cheap? Despite the large majority of attention being focused on larger competitor’s including McDonald’s and YUM!, especially in the swiftly-growing China market, Domino’s might present one of the most relatively inexpensive investment routes in the quick serve restaurant space. Following a near 33% CAGR in free cash flow between 2007 and 2011 and the corporation’s recent double-digit percentage drop in price, Domino’s may now present an attractive bargain. The following yield compares Domino’s to several competitors in the quick serve restaurant market on a sellable square footage basis – consumers purchase a given corporation (EV/square footage) and receive a given level of cash flow for that purchase (EV/free cash flow). Yield (the purchase price of the cash flow divided by the purchase price of the physical square footage) hints at a relative undervaluation behind an investment in Domino’s operations.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Papa John’s International. Motley Fool newsletter services recommend McDonald's and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.