Domino’s Pizza: Do Take Your Slice
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Domino’s Pizza (NYSE: DPZ) has provided good returns since revamping its pizza recipe about two years ago. The success of the brand new pie has allowed this leading pizza delivery company to expand domestically, and more importantly, overseas. The company’s stock price has gained 265% since the end of 2009. Recently, this rapid rise has seen a correction. However, we remain bullish because of the company's strong fundamentals and potential growth drivers in terms of technological improvements and overseas market expansion. Also, the company’s heavily franchised model allows it to grow with little capital investment, boosting free cash flow. Here are the key reasons for our bullish stance on the company.
Online ordering is a potential game changer: Online ordering, which now represents about 33% of U.S. sales compared to ~25% of the sales a year ago, is growing and is a potential game changer. The launch of an iPhone app last June and an Android app in February have provided a major boost in online ordering as mobile ordering now contributes more than 7% of total sales in the U.S. Online orders generate a higher check, lower labour costs and increased accuracy. Online ordering still represents a large opportunity, given that more than 40% of sales in the UK and more than 50% of sales in Japan are from online ordering. It provides the company a competitive advantage over the regional chains and independents. Domino’s, along with the other two top chains, Pizza Hut (owned by YUM! Brands (NYSE: YUM)) and Papa John’s (NASDAQ: PZZA), are likely to gain market share from regional chains, which own 25% of the market, as they seem vulnerable to the technology edge of the leaders (apps, IT support, etc).
More rapid overseas growth than its rivals: Domino’s has grown more rapidly overseas than its pizza quick-service restaurant rivals in the recent past. Going forward, continued expansion is likely to boost high-margin royalty revenue for the company. In the past six years, DPZ has outpaced its major rivals, Pizza Hut and Papa John’s, in new unit expansion overseas. It can more than double its current unit count of nearly 4,835 units in the coming ten years. Domino’s has gained 96 bps in market share, whereas Pizza hut has lost 111 bps in the last decade. In India, the company has established itself as the largest international brand and makes up 67% of the delivery market. In Turkey, Domino’s has posted a phenomenal same store sales growth of 14.5% over the last five years. In fact, the company expects the number of its international stores to surpass the number of its domestic stores this year, something that Papa John’s and Pizza Hut haven’t been able to do; overseas stores now constitute about 49.6% of total Domino’s stores. The following pie chart provides a detailed unit break up of Domino’s in different markets.
Company management aims to open 350-450 stores every year, with most of them being in overseas markets. These international stores can help the company reach an EPS growth of 5% and international revenue growth of 10%.
Lower Cheese Prices: The cost of cheese constitutes about 30-40% of the cost of goods sold. Cheese prices have gone down to ~$1.50/lb against a year ago price of ~$1.80/lb and peak levels of $2.15/lb. These lower prices will reflect a positive change in margins, and these margins will allow franchises more flexibility in menu pricing while still enjoying profits.
Other positives for Domino's include an increase in US profits/store and strong cash flows, which will help the company reduce its debt load over time. With a forward PE of 13.74x, a discount to its peer group of YUM Brands (17.06x) and Papa John’s (17.25x), we believe the stock is undervalued and recommend it as a buy.
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