Upcoming Earnings Release
Domino's Pizza (NYSE:DPZ) is scheduled to report its 16Q3 earnings Tuesday, October 18th before the market opens with a conference call at 10:00AM EST. Per Bloomberg LP: of the 16 sell side analysts providing estimates, the consensus revenue, comps and EPS of $542M, 7.5% and $0.89, respectively, are unchanged or slightly higher (notably comp estimates, up 50bps) in the past 2 months. Q4 and FY17 estimates have also been rising revised upwards this year as DPZ has delivered strong results. According to Bloomberg, the median target price is $154 (range $120 to $153), also increasing consistent with results. Domino's Pizza Group plc, the master franchise for the UK and Republic of Ireland (£900M system sales and >900 units), today reported Q3 system comps ~4.0% and renewed its outlook for the year despite H2 challenges.
DPZ: Company Overview
Domino's Pizza is an Ann Arbor, Michigan-based pizza restaurant chain, which, per its '16Q2 quarterly report, operated and franchised 12,936 units globally, generating an estimated $9.5B in sales (about 1.5M pizzas/day), making it the world's second largest pizza chain (after Pizza Hut) and the number one U.S pizza delivery company. About half the sales are produced by the 5,245 domestic stores (386 company, 4,859 franchised), while the other half are produced by franchised stores in over 80 markets around the world.
In the T12M through 16Q2 DPZ's revenues were $2.3B which were derived from company stores (18%), royalties and fees from franchisees (12% domestic, 7% international) , with the remaining 63% from sales of food supplies and equipment to company and franchise locations. We estimate the AUV's of company units are slightly over $1M (or about $700/sq. ft., assuming average store size of 1,500 sq ft). Disclosed store-level operating margins (which include depreciation but not advertising expense) are about 25%, while royalties from domestic and international franchisees are almost pure profit. We estimate domestic and international franchised unit AUV's are about 20% and 30% lower, respectively, than domestic company locations. Disclosed average store level EBITDA of domestic franchisees is about $120K, up from $61K in 2009. (These figures are presumably net of royalties, fees and advertising fund contributions). We estimate the cash investment for a new store at about $465K based on Franchise Disclosure Documents and other materials.
The supply chain provides pricing and distribution scale and uniform ingredient quality to participants. It operates 18 regional dough manufacturing and food supply chain centers in the U.S., one thin crust manufacturing center, one vegetable processing center and one center providing equipment and supplies to certain of the domestic and international stores. It also operates five dough manufacturing and food supply chain centers in Canada and leases a fleet of more than 500 tractors and trailers. As such, it makes approximately twice weekly deliveries of food supplies and equipment to over 5,600 system units, including all company stores and 99% of U.S, & Canadian franchisees. It passes through its prices paid with a small markup to participants and shares a portion of profits with franchisees, which nets out to a segment margin of about a 10%. The supply chain segment's relatively low EBIT margin and capital intensity are a drag on consolidated margins and free cash flows, making them lower than other highly franchised peers. Arguably, DPZ could boost margins by leaving supply responsibilities to franchisees, as, say, DNKN does, but it would lose scale advantages for both their own and franchised stores (less of a concern for DNKN with virtually no company stores). It would also diminish its ability to control quality. Perhaps most importantly, it would lose an important touchpoint with its franchisee partners. (We're not so much trying to decide the correct strategy as to point out key differences in strategies from other highly franchised peers.)
Domino's has gone through a variety of development stages since its founding in 1960. Its current stage is a brand revival which dates to the end of 2009 when it scrapped its original pizza recipe in favor of a line of premium (and distinctly better tasting) pizzas featuring higher quality ingredients and a wider variety of toppings such as roasted red peppers, spinach and feta cheese in addition to the traditional favorites. The company has gone counter to industry trends by avoiding LTO's and complicating its menu with a stream of new products. Instead it has concentrated on providing consistency and value with a limited and uncomplicated core menu of pizzas, baked sandwiches, pastas, chicken items (like wings), breads, beverages, deserts & extras (sauces). In the past 4 years DPZ has added just 2 items: Specialty Chicken in 2014 and Marbled Cookie Brownie in 2015.
The current brand revival stage is also supported by DPZ's "Pizza Theater" re-imaging of system stores (expected to be substantially complete in 2017); its innovative marketing (e.g. the iconic campaign trumpeting the scrapping of its former pizza recipe); and its use of complex technology to take the complexity out of operations and to improve the customer experience. One of the first with on-line ordering, DPZ has since developed a digital platform, which is nearing utilization by the entire system (including international units) to manage internal operations (re-supply, scheduling, payroll, order accuracy, etc.) and customer-facing actions to simplify ordering, payment processing (with a range of payment systems in addition to credit & debit cards) and enabling order tracking (from prep through delivery) on virtually any communication device. Together with a sophisticated loyalty program, the platform provides a rich source of data for its robust marketing initiatives. Not content with 50% of domestic sales transacted via digital orders and the fast growing international acceptance, the company is continuously improving the platform. For example, in 16Q2 it launched a "Zero Click Ordering" app, seemingly the penultimate in ordering ease (the ultimate being that your order appears by just thinking about it).
The proof of the brand revival is in the numbers. Since 2009, through 16Q2, revenues have grown at a 7.6% annual rate on comps averaging 7.1% domestically (including 21 consecutive Q's with positive comps) and 6.9% internationally (90 consecutive Q's of positive comps!) and franchise unit CAGR of 6.9% (almost entirely from franchise net unit growth, as the number of company operated locations has been virtually flat). During the same period EBIT, EBITDA and FCF have grown at annual paces of 11.2%, 11.6% and 12.4%, respectively. Long term the company expects global retail sales will grow at 7-11% on domestic comps of 2-5% and international comps of 3-6%, while net global new unit growth will be 5-7%. If it achieves these top line targets, margins will continue to expand and net income and free cash flows will grow at a double digit pace.
Per the '16Q2 report, Domino's has a strong balance sheet, though it has become highly leveraged similar to many of its heavily franchised peers, adding $887M net new debt in the last year. The ratios of total debt to T12M EBITDA and lease adjusted debt to T12M EBITDAR at 4.9X and 5.1X, respectively, are comparable with its peers. T12M cash from operations of $257.6M less $68.1M cap ex, leaves free cash flow of $189.6M. Its increased leverage and free cash flows financed T12M net share repurchases of $865.1M and dividends of $68.4M.
DPZ: Current Developments per Q2 Report & Conference Call
Domino's delivered a strong 16Q2, which makes the disappointing (for DPZ) Q1 seem a hiccup. Better than expected comps combined with 8.5% YOY unit growth drove top line up 12%. Of note, the Q's solid comps were almost entirely due to traffic increases (& flat pricing) credited to the recently launched loyalty program. This differs from most of the industry which experienced negative traffic that tended to more than offset price increases. Below the top line, all expense items tracked closely with sales, with the result that operating income grew at a modestly faster 12.4% rate, allowing the operating margin to expand 10bps to 19.0%. However, $6M of additional interest (to $25M) from the past year's increase in debt, limited th2. e growth of net income to 7.3% YOY. Finally, stock buybacks lifted EPS growth by 20.4% YOY to $0.98. The company does not give guidance, but management implied, during the 16Q2 conference call, that the current sales momentum would continue in H2. The Street, encouraged, raised its estimates for the year by 8¢, double the 4¢ beat in Q.
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