Scott Olson
Funding Thesis
After rebounding from its sub-$300 lows, Domino’s (NYSE:DPZ) has approached a snug value level. Domino’s has quite a bit going for it — its distinctive e-commerce interface, profitable provide chain section, worldwide presence, and money circulation technology are all indicators of a profitable enterprise with natural progress avenues. Nevertheless, at its present valuation, there may be not a sufficiently big margin of security to justify a purchase. Subsequently, I like to recommend a HOLD for Domino’s inventory.
Firm Overview
Domino’s is a restaurant operator and franchiser with greater than 20,000 shops throughout over 90 worldwide markets. The biggest pizza restaurant on this planet, Domino’s generated $17.7 billion in system gross sales in 2022. Its management (among the many 4 largest US chains) of the nationwide market is 42%, in line with Bloomberg Second Measure.
As of the top of 2022, Domino’s income might be damaged down as follows:
Royalties and Franchise Charges: 29.4%
Firm-owned Shops: 9.8%
Provide Chain: 60.7%
Amongst royalties and franchise revenues, practically 25% originate from worldwide places.
As seen via Domino’s income streams, it could be extra apt to name Domino’s a provide chain & client advertising and marketing enterprise than a pizza chain. Domino’s makes use of its community of 26 home and 5 Canadian dough manufacturing/provide chain services to pay attention buying, preparation, and last-mile supply for its North American places.
Competitors
Domino’s direct trade opponents are Papa John’s (PZZA), Pizza Hut (YUM), and Little Caesars. Domino’s has 32% share of supply {dollars} and 19% share of carryout {dollars} within the US amongst QSR pizza manufacturers — #1 in each classes as of This fall 2022.
Creator
The oligopolistic format of the trade offers Domino’s (and its main competitors) an unlimited economies of scale benefit over its regional and native friends. Its bargaining energy allows its leveraged place, which I will get into later, and likewise offers the big benefit of its vertically built-in provide chain.
Domino’s greatest monetary differentiator is its debt place — at present, Domino’s sits at a 3.28 D/A and a 6.25 Whole Debt/EBITDA ratio. I will clarify how this works to its favor in a second.
Domino’s aggressive benefits encompass its intangibles, like its model identify, its international franchise community together with good relationships with its grasp franchisees, measurement, and main e-commerce interface.
Competent Technique
Domino’s has carried out numerous methods which have aided its success.
Its provide chain section is very profitable. Not solely does it profit Domino’s by permitting for centralized buying, extra environment friendly protection of shops, and elevated entry to produce chain information, however it advantages franchisees through quick access to supplies and profit-sharing agreements. For instance, a franchisee can get their dough shipped immediately moderately than having to spend time making it. With the opening of 4 new main facilities within the final 5 years, this has been Domino’s fastest-growing section — up 38% since 2019. I discover that the symbiosis the availability chain integration creates between Domino’s and its franchisees is immensely helpful for each events, and, ought to Domino’s be capable of broaden this section internationally into a serious market like India or China (although this seemingly will not occur for a number of years, if in any respect), I consider that its benefits will solely be compounded.
Domino’s has additionally centered its consideration on worldwide improvement, utilizing grasp franchisees to get a foothold in overseas markets. These partnerships are sturdy — 4 out of 5 main companions have a $2 billion market cap.
One of many issues that allowed Domino’s to climate the pandemic so properly is its digital presence. Its e-commerce interface is very developed for the trade, coupling GPS monitoring and AI-powered routing with fast and simple ordering, a strong rewards program, digital-only offers, and extra. Greater than 75% of Domino’s gross sales are digital, which is main amongst main gamers. Domino’s has 85 million completely different prospects in its database, and its “AnyWare” ordering platform permits for ordering not solely via the Domino’s app, however throughout platforms, together with Fb Messenger and Twitter.
This stage of digital success is also much less labor-intensive, which is useful in right now’s tight labor market. Proof of its digital success might be seen via its pandemic progress — whereas different opponents have been floundering in an try to breach the digital house, Domino’s capitalized and raised its international QSR market share from 1.6% to 2.2% from 2019 to 2021.
Different methods embrace fortressing, which primarily consists of flooding the market with shops. The thought is to attempt to broaden perform market share by making Domino’s a extra ubiquitous model, even at the price of probably stealing enterprise from present Domino’s. I think about that, someplace on the market, there are legions of economists sputtering about inefficiency, however Domino’s has proved them unsuitable, efficiently securing a bigger a part of the carryout pie. Perform is a bigger piece of the QSR market than supply — in concept, offering an extended runway for progress.
Final, even within the face of increasing competitors through the expansion of supply categorically, Domino’s has doubled down on its core competencies of value and comfort. I discover this to be well-thought out, because it exposes Domino’s to a lot much less operational threat than menu diversification or different untested initiatives.
Worldwide Presence and Natural Development
Domino’s is the chief in worldwide QSR Pizza, which I consider offers them a major progress benefit as developed markets grow to be saturated with shops. For instance, Domino’s anticipates practically doubling its retailer depend in India and opening ~4600 new shops in China ultimately. Whereas I discover these projections to be optimistic, if even a part of that progress is achieved, it may be anticipated that worldwide franchising income would enhance considerably (and probably function motivation to broaden the availability chain enterprise internationally).
Domino’s
Worldwide revenues have expanded ~22.5% since 2019, whereas U.S. revenues have elevated solely ~17% for a similar interval. Given the ubiquity of the COVID pandemic, I do not anticipate the COVID supply tailwind to have affected one in every of these figures disproportionately.
Domino’s per-store EBITDA has risen a mean of 10.2% CAGR since 2010, which ought to compound upon retailer progress internationally to outperform its main opponents. Worldwide retailer gross sales progress has outperformed home gross sales progress lately, so I anticipate Domino’s worldwide presence to be a significant component sooner or later.
Money Circulate and Shareholder Returns
Domino’s has generated >$600 million in FCFF since 2020, with an FCF to Web Revenue ratio of 1.02. This spectacular stage of money technology has allowed Domino’s to distribute money to shareholders even after reinvestments into the enterprise.
As proof, Domino’s has one of many healthiest traits of share buybacks of any firm, and money technology implies potential room for dividend progress. Domino’s has purchased again 20 million shares since 2013, 36.2% of complete shares. I anticipate the continuation of this development, severely limiting any threat of dilution.
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Shares Excellent in Thousands and thousands 56 56 56 50 48 43 41 39 39 36 % Change N/A 0% 0% -10.7% -4% -10.42% -4.7% -4.9% 0% -7.7% Click on to enlarge
Typically, leverage is seen as a warning signal. Nevertheless, Domino’s leveraged technique has lived via a number of monetary crises already, suggesting that the corporate is unlikely to undergo monumental losses on account of its debt place. Additional, the weighted common rate of interest of its $5.25 billion in debt is just ~3.77%. A majority of this debt will not be due till ~2028, which can be favorable for the leveraged place.
I discover Domino’s buyback habits to greater than make up for its poor dividend.
Lastly, as a little bit of an apart, the corporate’s lack of direct involvement with its eating places permits for extra environment friendly capital administration on a macro stage.
Valuation
For my DCF, I used the next inputs:
Income Construct & EBITDA Margins $ in thousands and thousands besides share-related objects 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 Income 3,432.90 3,618.80 4,117.41 4,357.37 4,537.16 4,647 4856.68 5138.28 5426.146545 5751.123193 % Development 5.42% 14% 6% 4.13% 2% 5% 5.80% 6% 6% COGS/COR 2,130.20 2,216.30 2,522.92 2,669.13 2,888.55 2876.636 3006.195 3180.501 3358.684706 3559.839261 % of Income 62% 61% 61% 61% 64% 62% 62% 62% 62% 62% Gross Revenue 1,302.70 1,402.50 1,594.49 1,688.24 1,648.61 1,770.73 1,850.48 1,957.78 2,067.46 2,191.28 Gross Margin 38% 39% 39% 39% 36% 38% 38% 38% 38% 38% SG&A 372.50 382.30 406.61 428.33 416.52 467.5345 488.5914 516.9209 545.880883 578.5741651 U.S Franchise Promoting 358.50 390.80 462.24 479.50 485.33 503.4942 526.1707 556.6791 587.8664714 623.074307 Refranchising achieve – – – – 21.17 – – – – – Working revenue 571.70 629.40 725.64 780.41 767.93 799.71 835.72 884.18 933.71 989.64 Working Margin 17% 17% 18% 18% 17% 17% 17% 17% 17% 17% Different Revenue – – 36.758 – – – – – Curiosity revenue 3.3 4 1.654 0.345 3.16 3.015606 3.151424 3.33415 3.520941936 3.731814219 Curiosity expense 146.3 150.8 172.166 191.806 198.25 198.7372 207.6879 219.7301 232.0402589 245.9373523 Provision for Revenue Taxes 66.7 81.9 63.834 115.238 120.57 132.8764 142.0168 153.5902 165.7208645 179.3831812 Web Revenue 362.00 400.70 491.30 510.47 452.26 471.11 489.17 514.19 539.47 568.05 Web Margin 11% 11% 12% 12% 10% 10% 10% 10% 10% 10% % Development in internet revenue 10.69% 22.61% 3.90% -11.40% 4.17% 3.83% 5.12% 4.92% 5.30% Diluted EPS $8.35 $9.56 $12.39 $13.54 $12.53 $13.24 $13.94 $14.86 $15.71 $16.66 Click on to enlarge
And for my WACC, the next:
WACC Calculation Present Share Worth 322.22 Whole Shares 36,093,754 Whole Debt 5,252,354,000 Debt Weighted Common Curiosity 3.77% Beta 0.73 Threat-Free Charge 4.74% S&P Return 9.10% Money Steadiness 60,356,000 Market Worth of Fairness 11630129414 WACC 7.4700688849487600% Click on to enlarge
I used a terminal worth based mostly on a terminal progress price of two%, which I discover affordable given the relative maturity of the corporate.
I used a revenue-segment based mostly income build-out, basing my assumptions on a harsh 2023 after which imply reversion of progress in every section (some progress charges declining, like US franchising, whereas others elevated barely, like worldwide franchising). Double checking in opposition to FactSet analyst estimates, we’re principally in settlement on the highest line numbers. After going via the mandatory calculations, assuming that almost all bills are held near-constant (slight decreases in some instances) as a p.c of income, and utilizing historic averages for issues like change in internet working capital, I landed at a good worth for DPZ of $327.14 at a 2% terminal progress price. This offers minimal upside, which, regardless of some comparatively bearish assumptions on my half, doesn’t present a adequate margin of security for me to advocate a purchase at its present value.
I did account for buybacks in different instances, however this nonetheless solely raised upside to 8-9%, not fairly sufficient for me to recommend a purchase.
Dangers and Different Concerns
Regardless of this not being a purchase advice, I nonetheless suppose it is essential to level out potential dangers with Domino’s. I discover the principle dangers to be as follows:
Present macroeconomic atmosphere will not be favorable to sectors reliant on discretionary revenue, pressuring supply revenues
Enhancements in supply categorically stress supply market share
Domino’s has skilled some staffing points that will put upward stress on working prices
Commodity value inflation within the close to time period places stress on the availability chain section, which accounts for a majority of income
Resulting from mid-single digit income progress, any stress on margins severely limits upside
Regardless of all this, I discover Domino’s tailwinds to be adequate sufficient for a usually bullish sentiment on Domino’s long-term — however at its present valuation, not fairly sufficient to warrant a purchase.
The Backside Line
In my opinion, Domino’s sits at a really comfy valuation proper now. Based mostly upon its worldwide market place, money technology and shareholder returns, and administration’s very competent dealing with of the enterprise, I discover Domino’s to be a high quality enterprise that’s greater than value holding a place in. Nevertheless, I discover its upside to be restricted at its present value, and recommend a HOLD.
