Dominio's Pizza Is Still Worth Holding At Its All-Time Highs
- Domino's pizza has doubled sales and tripled EBIT in the past ten years.
- Further market share gains, international expansion and the secular growth of the delivery industry will continue to lift the business.
- DPZ is still a stock worth holding assuming we continue to monitor some underlying trends.
Domino’s Pizza (NYSE:DPZ) was able to deliver the performance of a high-tech growth company in a sector that is usually considered mature by everybody, and which is actually mature if we focus on the overall sales growth. Revenue and EBIT have been in a strong uptrend for years and have basically doubled and tripled respectively, since the bottom reached in 2009:
As a result, the company’s shares have delivered a 20% compound annual return since then. Driven by the increasing penetration and market share growth at the expense of more fragmented players even in a market that shows flattish growth, the stock’s EPS multiples have expanded to the 40-45 area, before contracting a bit in recent times as a result of the slower, albeit still excellent, growth rates reported in Q4.
DPZ’s longer-term growth rate still assumes a 3% to 6% comps growth and a total 8% to 12% sales growth, and while the company’s top line growth fell to single-digit territory in Q4 for the first time in two years (+8.8%), the management still has a very optimistic view about Domino’s growth prospects:
And certainly, they've been outperforming anybody and everybody since the beginning of the decade, but that doesn't mean that we're not going to continue to try to hit the 3% to 6% comp range and, ultimately, the 8% to 12% global retail sales metric that we gave you for the next 3 to 5 years. We want to be balanced, but we want to try to outperform that as well, if we can, of course, right? There is no [governor] on the business. We're not at capacity or anything like that. So we can continue to grow, I think, as fast as we can grow. It's just up to us to execute.
Source: Domino's Pizza at BoAML Consumer & Retail Technology Conference
The key message is that we are not even close to saturation as far as Domino’s business model is concerned, and a performance similar to the recent top line and comps grow can be achieved through proper execution in the current environment. I don’t think we should be too skeptical about the accuracy of the management’s expectations.
The business has delivered much more than anybody would have expected in the past 10 years and has shown to have a great stability and scalability, plus a positive operating leverage that led to an EBIT margin expansion from 13.6% in 2009 to 18.7% in 2017. There are a few intrinsic characteristics of Domino’s business that make me positive about its future growth prospects:
A low international penetration. As of December 2017, the international segment accounts for just 13% of total sales and has never been an important driver of growth. Considering the overall success that North American restaurant chains tend to have almost everywhere in the world, and the more positive economic and demographic trends outside the US, the low international penetration is a factor that should guarantee many years of growth even in a scenario of faster-than-expected saturation of the domestic market.
Market share growth. The huge expansion in a pizza market that is seen at or near saturation confirms the superiority of Domino’s business model, while the significant fragmentation of the market and the large share in the hand of smaller and less efficient players indicates the possibility of further market share growth. Domino’s already controls 30% of the $10 billion pizza delivery market in the United States, up from 20% in 2011, and foresees further market share gains in the future.
Nonetheless, the management has clearly stated that they are not looking at the industry and the business just in terms of pizza delivery and pizza takeout, but rather in terms of food delivery and food takeout markets, putting the company in direct competition with other restaurant chains and food providers, but expanding the total addressable market dramatically to include the whole quick service restaurants market, which is estimated to be worth around $300 billion in the United States alone.
In this context, the company’s focus on the expansion in the takeout market helps differentiate the strategic approach compared to many competing restaurant chains that are mainly focusing on riding the delivery service revolution, where Domino’s Pizza already dominates.
Competition And Risks
What we should pay attention to is the potential increase of competitive pressures from similarly sized peers such as Pizza Hut, which may continue to try to take market share and start to be more aggressive on the pricing front, exerting pressures on sales and margins. This problem has been discussed by the management, who also highlighted how competitors such as Pizza Hut basically replicated Domino’s promotional strategies such as the “2 for $5.99” offer.
The management didn’t deny the possible detrimental effect of pricing competition and the possibility that DPZ will have to respond to those competitive pressures through further promotions. On the other hand, they expect the business to grow regardless of pricing competition but omitted to comment on the potential damage that increasing promotions would cause to margins. I think this is an aspect Domino’s shareholders or potential buyers should monitor, as it may affect bottom-line growth prospects and increase the downside risks for the stock at the current multiples.
Besides that, I think there is another risk that should be monitored even more closely, which is related to the attractiveness of the delivery business and the increasing competitive pressures that the company may face from large QSR operators from other areas of the food industry.
Players such as Mc Donald’s (MCD) have become more aggressive in the delivery business, pushing the number of restaurants that offer this service to 5,000 in the United States and to 6,000 globally, with the expectations of a further increase in the next years. Yum! Brands (YUM) gives us another example of this phenomenon, with the company emphasizing its projects in the delivery business:
I want to highlight an example of the power of Yum! in KFC's global delivery initiative, which we're aggressively pursuing as a strategic growth opportunity. We currently deliver out of almost 6,000 stores and plan to expand this rapidly over the next few years for many reasons. Not only do consumers want it, but KFC's product is ideal for delivery as it holds temperature and quality remarkably well. Also, the vast majority of sales are incremental, since it captures a different consumer occasion.
The increasing competitive pressures from other QSR operators trying to grow their market share into the delivery business can pose a risk to Domino’s ambitious growth plans, as everybody seems to be excited about the market potential in this area.
Considering that pizzerias in general already account for 60% of the food delivery market, with a $126B slice in a $210B market (according to JPMorgan), and largely benefited from the limited competition from fast-food chains and other food providers so far, there may be more risk than opportunities in this area. Therefore, while the overall segment is growing, so are the competitive pressures from large QSR players trying to gain market share in this promising business.
Domino’s Pizza remains a solid business with excellent growth prospects. I see a significant potential to increase market share at the expense of smaller and more inefficient competitors, which could drive DPZ’s market share well above its current 16.7% overall growth, and we may even see a further increase in the company’s market share in pizza delivery from the current 30% if the business continued to increase customers' loyalty as it has done in the past few years.
Besides that, we have to consider that the overall delivery market is enjoying a strong trend of secular growth driven by changing consumer habits, which basically makes the whole pie bigger for all the most efficient players, a group that obviously includes Domino’s. Last but not least, the low international penetration highlights an underexploited growth opportunity that may guarantee many years of growth even without further gains in the domestic market.
I still see the stock as one worth holding at the current valuation, although not cheap at almost 30x full-year earnings. Keeping this stock in a diversified portfolio still makes sense, assuming that we keep monitoring competitive pressures and the developments in the delivery business.
This article was written by
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