Domino’s Pizza, Inc. (NYSE:DPZ)
Morgan Stanley Global Consumer & Retail Conference
November 20, 2013 9:45 AM ET
Michael Lawton - Chief Financial Officer, Executive Vice President
John Glass - Morgan Stanley
Thanks. Good morning everyone. My name is John Glass. I’m Morgan Stanley Restaurant Analyst. It’s my pleasure to introduce our next presenting restaurant company Domino’s. Since 1960, Domino’s has changed the way we order and eat pizza and pioneering what is today considered a life necessity delivery pizza. It was also the original online business. It just happen to be the 1960s online meant the telephone line, today online means something very different and in fact Domino’s has been a pioneer in all the restaurant industry for online ordering and now mobile ordering.
Company is not just pioneered in United States; it’s across 70 countries and their system over 10,000 units. Today it’s my pleasure to introduce to you Michael Lawton, the company’s Chief Financial Officer. We also have Lynn Liddle in the audience who runs Communications and Investor Relations.
Mike with that let me turn over to you.
Thank you, John. So obviously we have forward-looking statements that I’d point you to. In the event that I say something I shouldn’t but jump right into the presentation.
Now, why invest in Domino’s? A few things to think about then I will go into more detail on each of these. We first – we have a very strong domestic business. We are a popular brand, very well known. And if you look at our track record over the last several years we have been doing really well. We relaunched our product just over 4 years ago up until that point in time we were known as being great service as John said that guys who were going to bring you a pizza, fact of life, if you need a delivery but now we also sell something that we think that we are very proud of it’s a product that tastes really good. And that’s really helped the brand image.
In the U.S., we are primarily franchised, which means that we make most of our money off the top line as opposed to the bottom line. The risk as you have ups and downs in the economy we are in a competitive environment is at the store level, we make our money primarily off royalties, we have about 10% of the stores are store owned, are corporate owned in United States.
In the U.S., we also have a value added supply chain, value added in that our franchisees are happy to be dealing with us because we are a one stop shop. We will bring them product two or three times a week. We get a good return on investment from that. It’s not a high margin business. It’s in high single digit, low double digit but the return on assets is good and it’s got a lot of stability because we know who our customers are.
The international side, which is where we have great growth, we are entirely franchised. We deal primarily through a network of master franchisees. We are collecting on average about a 3% royalty. We have some support costs but it’s a very profitable business. And this is where the great growth has been in terms of store count over the last few years. And we are very optimistic about what the future looks like.
Turnkey for us that sets us apart from some other companies is the fact that we have been leveraging technology in a big way. We are now at a point where over 35% of our orders come in over digital means, consumers like it. It’s what sets us apart. This is not about ticket growth, this is about transaction growth and we think there is still a lot of opportunity for us to grow in the digital arena. We also do a lot of digital marketing, managed through our corporate headquarters, whether that be paid search, banner ads or other social media.
The last thing that I will get to is, we go through the presentation is to talk about our balance sheet because of the fact that our cash flow have historically been relatively stable. We are comfortable dealing with a reasonable amount of debt. We are currently running with debt ratios of EBITDA to debt of about 4.6. We have been much higher in other points in time as I show you. We also have a good history of returning cash to shareholders whether it be in the form of stock buybacks, a regular dividend which we initiated earlier this year or even special dividends.
So Domino’s, right now about half the business at the retail level is inside the United States with half outside. And our store count has become roughly the same, last year our international store count surpassed the United States for the first time. Inside the U.S., we got about 4,500 stores that are franchised, 390 that we own corporately and a supply chain that I mentioned earlier has 19 facilities including the facilities that handle the production of fresh vegetables for the stores and the production of some of our bread products or crust products.
On the international side, at the end of the third quarter, 5,600 stores spread around about 70 countries and none of them corporate owned.
So more on the domestic, what’s important to us is that not just are we collecting a royalty but that our franchise model generates good returns for franchisees. We hit a low point for this in 2008. We were not doing as well as we are today, franchisee profit kind of bottomed out with an average of about $50,000 per store. Since that point in time, it’s increased more and last year it was in the $75,000 range and this year we will surpass that so giving them very good cash on cash returns in robust [inaudible] business. This is a type model where it doesn’t take a big investment. We don’t charge a lot for upfront piece, we make our money off the royalties in the long-term.
One of the interesting things about the pizza business is that compared to some other section of QSR particularly hamburger is just much more fragmented. You know, the top competitors in the United States which include Pizza Hut and Papa John’s have about a 50% share, the smaller chains they have a 100 to 500 stores have about a quarter of the market and then the mom and pops have the other quarter.
One thing that we have seen and changing in the last three years is that the regional chains are starting to give up a little bit of share because this pie chart hasn’t changed a lot and had not changed much for quite a long time. But, we think that with the advent of what can be done with digital ordering and what we are doing with digital marketing we think the regional chains are starting to feel a bit of a squeeze. Our bigger competitors have also indicated that they see it the same way.
We think what we are doing with the digital, we are making big investments, we think it’s really hard to do with your small chain to keep up and we think it’s something customers really like, so we think its going to have a long term impact.
Domestic supply chain, as I mentioned sells and delivers food and the equipment to the franchisees. Yes, we make some money off this, it’s a good return, but in addition to that it keeps franchisees focused on their business.
We are a one stop shop, they get everything from us. And it helps the product quality and the consistency of what we sell in the stores because we have got good controls over the product because of the fact that we do profit share, the profits in there. We make the investment, we are running the business but we do share the profits. Franchisees have opted in and all but a handful of stores are using our supply chain in the United States.
One question, we typically get is about commodity cost, this year commodities have been relatively tame. We expect them to wind up the year in the plus 2% to 3% range versus last year. Commodities for us, the biggest piece is cheese, it’s meat, boxes, wheat; many of you that follow the food market would know that corn prices have been coming down, the grain prices right now the best estimate is, that is as we go into 2014 commodities will remain very manageable for both us and for our franchisees.
I would point out that as you think about the ups and downs of commodities, it doesn’t have a lot of impact on us in our supply chain because we basically make a penny profit per pound and we move our price up and down so that ups and downs are absorbed at the store level.
I mentioned technology because it’s one of the areas that we are really proud of what we have been getting done. We now have different technologies on mobile devices that over 95% of mobile devices can access our system to place orders. We have had huge numbers of downloads of our different apps. You can now do a card on files similar to what you can do with other big retailers which I think is still unique in the QSR industry. And we are approaching 40% of sales coming off digital.
Despite everything we have done, the good part is that when we look at what is still out there in terms of opportunity, how can we make this experience better for our customers, we can lay out ideas with technologies that are there today that keep us – that are going to keep us busy for the next three years.
And technology is really nice for us because it gives us a way to talk to our customers about innovative ideas and changes that we are making without just having to launch new products into the system which are good and something we will be doing and we will continue to do but we don’t have to – every time we have a new advertising window we don’t have to be talking about a new product that’s in and out over a very brief period.
Turning to international, 91% of the money that we make in internationals coming from royalties, the remaining 9% is coming from our commissary system that we own up in Canada. So it is, as we grow the retail level sales in the international arena, much of that money is flowing into the bottom line very limited investment in capital through a master franchise model. Our retail sales growth has been pretty good at the system level and we are doing 12% a year, with good same-store sales growth as well as store growth.
And the – we are now at a point where we are rated as – we have more international stores that [indiscernible] other competitors. We’ve become a very big player in the international arena over the last 10 years. And have a lot of future in front of us.
Five year growth, it has taken us from 3,500 stores up to 5,300 same-store sales growth running 4% to 6%. Same-store sales I would point out as you look around the world, we are doing well in all regions. This has not been a phenomenon where Europe is great and Asia is weak. We are not recession proof. We’ve had a really deep recession in certain countries. It has impacted us. But overall, we have been able to grow in most markets on a relatively consistent basis. And I like the fact that we are positive – we are positive and the vast majority of markets that we deal in.
Even though we are big in some countries, we are certainly not mature in many. If you look at our top 10 markets, we still have a potential growth of – we think at least 2,500 stores. You look at market up to like the U.K. where we still have -- clearly have more growth and we are in a number one position.
If you look at India, we are in a number one position and we use an estimate that our Indian master franchisee use public uses in terms of opportunity but given that they are growing at a 100 stores a year and maybe more [indiscernible] than a 1,000 stores to be add. But, we try to be a little bit on the conservative side with these numbers. But, there is a lot of growth just in our top 10 markets, what’s our top 10 today. And we are in about 60 more markets some of which are up really significant and have a lot of potential. And many more markets where we got a number two or number three position, somewhere we have a number one and still have a lot of room to go.
We have got presence in virtually all the big countries in Western Europe, we’re in some of the Central America – Central European countries doing well, so lot of growth that goes beyond just those markets that we’ve got great presence today. We are beating our competition in terms of growth. We have in every year for the last five years. Our Pizza Hut is the leader in total pizza around the world but we’re gaining on them and each year we’ve been able to open more stores outside the United States.
In fact, 43% of our international store growth has come since 2008 which does lead all of the QSR competitors. One thing that’s different about us from some other QSR groups is that there is a lot of visibility on our international markets from the fact the many of these stores – many of our stores are owned by public companies, there is a big group out of Australia, a big group out of U.K., one out of India and the group in Mexico. The great part for us is that as master franchisees that have gotten big enough that they have gone public as a public company anywhere, there is a certain amount of pressure on them to grow, that helps us because they grow and it grows our royalty income.
Turning to capital structure, we use an asset-backed security type of debt, the good part for us is that when we issued our debt we felt like we were getting a favorable interest rate that does come with some constraints in terms of refinancing which is a question that I often get and why not refinance now that – it’s the most opportune times we are kind of locked in, we will keep this debt in place for on extended period, we’ve got six more years left to maturity. We do have the ability to stop amortizing this debt if and when we get to a point where debt-to-EBITDA goes under 4.5x and we’re close to that number right now.
We also have variable note facility if needed. So, we’ve got plenty of access to capital through net foreseeable – our foreseeable needs and we’ve got a pretty good piece of financing in place.
EPS growth has been significant, generally in the high-teens to over 20% certain quarters, it did very well up to the last reported numbers for us which was third quarter of this year. I did want to show you kind of a history on global same-store sales. You can see in the U.S. that’s averaged about 2.5% over an extended period with the last few years until we really relaunched the brand, we relaunched our product running higher than that. In fact, so far this year we were at the end of the third quarter up in the 5 plus range. International same-store sales very consistent and now going way back to 1994 in fact on [indiscernible] 86 great quarters now since we had a down quarter international.
We don’t give quarterly guidance or annual guidance, but what we have tried to do is give an indication of what we think the long-term may hold for us and we think on an annual basis we’d kind of expect to be in the – growing our store count at 4% to 6% a year, most of that coming from the international markets, domestic same-store sales in the 1 to 3 range, international same-store sales probably more in the 3 to 6 and global retail sales growing at 6 to 10 which obviously generates primarily royalty income for us.
We are a company that will continue to invest and grow in the business but other uses of cash flow would include a moderate amount of amortization unless we were able to stop because the debt-to-EBITDA grows to a certain levels. We have repurchased significant numbers of shares over the last four years and have the ability to do continue to do so. We have paid on more than one occasion, special dividends because we think – we don’t have a great need for cash in this business. We’re not likely to go out and make major investments in the second brand or anything. We’re more inclined to be returning cash to shareholders in one form or another.
We did initiate a quarterly dividend earlier this year and have paid $23 million so far. So why invest strong product demand, we’ve got great demand outside the United States and our growing business in the U.S., very strong unit economics that have been improving for the last five years in the United States and many of the foreign markets. And very consistent cash flow because of the fact we’re primarily a franchise business model.
So, I’d like to thank you for your coming in to see me today, appreciate your interest in Domino’s. With that I’ll take the questions. John?
John Glass - Morgan Stanley
Let me start up Mike with a couple of questions and then please everyone else chime in. One is, if you could just walk us through – in the U.S., your change in promotional stance that used to be a limited time business where you’ve moved to much more of a consistent everyday offer and you’re trying to eliminate that kind of volatility that, that induces. So if you can talk a little bit about how that migration has been successful?
And then secondarily thinking about how you market the product, because 40% of your sales are online, you’re probably well ahead of others in terms of digital and online advertising, how does that work, do you think you can continue to migrate on to that platform given how effective I think dollar for dollar that is relative to traditional media?
Okay. So the first question is more about the marketing and the launch of new products. If you go back to five, six, seven years ago we were probably launching six new products with marketing support a year. And many of those products were launched with a lot of marketing dollars behind them, you as a customer might try them and by the time if you decide to go back and buy the product again it was already off the menu. We were doing that because you need new, you need something that’s innovative to give you a reason to communicate to your customer. But what we have found and the direction we’ve tried to go and have successfully gone over the last four years is to do fewer new products but have new products that are tested, new products that we’re willing to make serious commitment to and new products that we think are likely to stay on the menu for an extended period.
So during the past year we actually haven’t even launched a new product not because we haven’t done anything innovative but because we think there are other things that are interesting to consumers. We’ve spent – the current ad campaign that’s out there actually talks about some of our more recent innovations in digital and why you may want to use a digital way to access us and place an order than using the telephone.
We think there is a lot of different ways to communicate that we are an innovative brand and is not just about new product or what we could derogatorily call the product of the month, this wasn’t really getting us anywhere. So if you see new products from us, it’s something that we think is good, we think it’s going to be something that’s been well tested with consumers and that we think has a real good chance of staying on the menu and we think this is a good way to go. We do want to stay innovative but just doesn’t - innovation doesn’t have to mean new products.
The second part is – the question is more about how we changed our marketing and our communications with consumers. This used to be a business that was very much about print, local store marketing effort by getting our franchisees, getting in the community, meeting with people, trying to sell their product that way and TV.
We are shifting more and more away from print and more into digital. Digital whether it be paid search or banner ads or social media that is definitely the way consumers want us to communicate with them particularly as you could imagine the typical pizza customer is younger than I am. They are looking at digital, they are looking at social media much more and that’s what they are looking for and I think we’re clearly trying to lead in that direction, we are responding to what the customer wants.
John Glass - Morgan Stanley
Is that result and you’re actually being able to lower your advertising spend or is it the potential to have you be able to lower it and still get more efficacy?
What we’ve done is bring more of the marketing dollars from the local level into the national level. Our franchisees have agreed on multiple occasions to increase the amount of the contribution that they are making to the national ad fund in fact we are at 6% now which is a very high level. And I think gives you an idea the support that we have from our franchisee base and the trust that they have in our marketing department. Overall, they may have kept the marketing dollars the same or may have dropped them a little bit but more important is that by putting them at the national level we get more effective both cost effective spend and also – or efficient spend but also we think something that’s more effective than the dollars that we use to spend at the local level.
John Glass - Morgan Stanley
And just one other questions on that topic, have you – what is the rate of adoption – what is the rate of adoption curve look like from an online standpoint or is it slowing, is it continue to accelerate at a certain rate. Do you feel like you’re going to reach a point where there is a certain customer just doesn’t want online?
The growth is ranged -- is running above 5% more customers a year ordering online and we have really seen that tail-off. We do have a couple of countries that could give us an indication of how far it could go and that would be markets like Japan and Korea where I think the consumer is actually ahead of the U.S. and they have numbers that are up over 50%. The big benefit to us as the customer going online is not so much about tickets, it’s about transactions, they are more likely to come back to us, they like the experience better than being on the phone, they see the full range of products that we sell. There are a lot of people that still think of Domino’s as okay I could call and get two pepperoni pizzas and a coke, but we’ve got really good sandwiches, really good pastas, we have a lot of other products that people will buy when the menu is in front of them like it is when you order online and I think that’s helped our frequency a lot, but I think they are still looking for that to continue to grow.
John Glass - Morgan Stanley
Thank you. Questions from you all. Yes ma’am.
I was wondering are you seeing any kind of innovation in the industry on the product side, I mean you said that you haven’t offered any major new products in a while, but just curious to see are you seeing -- what kind of innovations are you seeing and what is your view on kind of protecting your market share, is it just kind of based on market growth?
Okay. Well, when I said we have not launched a new product so far this year but last year we launched Pan Pizza. And the product that we had competing in a category that represents 20% of the pizza business was something that we just viewed as is not adequate. In fact if you saw our ads you would see that we were somewhat critical both of us and our competitors because of the product that was out there. And we launched a product in October of 2013 that was aimed right at a category that we thought could be doing a lot better where it’s been very successful for us.
We have more products and as we go through 2014 it’s not likely that we’ll go through another year without launching new products into the marketplace. My point being earlier though was more if we do fund there it’s going to be funds that we’ve probably [betted] [ph] more thoroughly than you would if you were trying to bet, trying to introduce six products a year, but there will continue to be innovation in the category, food innovation.
You mentioned that you shifted more advertising focus on the electronic means of ordering. Could you talk just the effectiveness of that if you are seeing an acceleration in the order pattern and the acceleration of the downloads of the apps, things or metrics such as that would show how that’s helping?
Well, if you look at the results so far this year and through the end of the third quarter; we’ve now as you saw from the chart we’ve had, this would be the fourth straight year where same-store sales growth was greater than 3%, some of that is clearly related to product between the relaunch of our core hand-tossed product four years ago was a big – was a necessary and very important room for us to launch a pan.
And in addition to that there – we don’t think its just product that got us above market share, above industry growth. We think part of the reason we’re gaining is clearly because of what we’re doing with the digital. It’s hard to put exact dollars on -- just spend a dollar on advertising what you’re getting, but what we can clearly see is, if you start ordering from us digitally and customers in the pizza business are not real loyal. Many buy from us one day and then two weeks later they’re buying from someone else. What we can clearly see is, if you switch to us you start buying from us through digital means, you’re probably going to give us a bigger share of your orders and that’s pretty clear.
John Glass - Morgan Stanley
Can you talk a little bit about ObamaCare and how it’s affecting the unit economics? Thanks.
The Affordable Healthcare Act is not really having an impact on unit economics today and is probably not going to have a lot of impact on our franchisees next year or and we’ll probably come in over time after that, but it starts to have some impact. For many of our franchisees who have a small number of stores that may never have an impact because if you got one store you don’t have enough full-time employees and even some of our people that may have a few more stores.
I think over time most of the – some of the franchisees are providing some level of healthcare to managers today, they may see an increase in cost but hopefully all manageable within their level of their stores. It has more impact at the store level at least as we proceed see it today, it has more level on, the store level and including our corporate stores [indiscernible] much help to the business. And we think it’s just manageable but it’s something that still have to be quantified as it becomes clear exactly what it’s going to do over the next three, four, five years.
John Glass - Morgan Stanley
Time for one more if there is.
Who is your biggest competition for franchisees?
Our biggest competition for franchisees? We don’t do a lot of recruiting the franchisees from outside of the Domino’s system in the United States. Most of our franchisees started working for other franchisees or within our corporate stores came up through this system and decided that they wanted to invest in the business. So we really don’t have competitors in it.
But do you have attrition rates of those existing, what’s the attrition rate of the existing franchisees?
The attrition rate until they retire is fairly low but even as they leave they are either being -- their stores would either be absorbed by existing franchisees or so other people coming up from within this system. We really do not have many stores owned in the United States from people who didn’t come from within the Domino’s system. That’s just not the way we have built the system over the years.
John Glass - Morgan Stanley
Okay. Thanks very much. We are out of time. So please join us in the break out room to continue the conversation.
Thank you, John. Thank you all.
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