Domino's Pizza $DPZ
An enticing slice of pie or a stale tomato?
Domino’s has a terrific history as a company that has created value for shareholders and depending who you ask, their pie ain’t bad either. You’ll likely recognize the brand and maybe even know the product well. With a market cap of just under 16 billion USD and the enterprise value of 20 billion or so, this isn’t a tiny operation. The benefits of scale should be somewhat obvious for a pizza place.
What do they do?
They operate and franchise pizza restaurants for dine-in and takeout. They have been around since the 1960’s and started as a one store pizza parlor in Michigan (the state best known for their amazing pizza, right?). Since then, the pizza business has scaled to just under 400 corporate stores and over 17,000 franchised units. The growth has been tremendous over the past decade and is continuing at a steady pace, expanding the size of the pizza pie, as it were.
Do they make money?
Over the past decade top line revenues have grown in the mid-single digits to just over 30% on occasions (per year). Gross margins have been slowly increasing from around 25% (respectable) to 38% (very nice). Keep in mind, we are talking a high turnaround business with a simple model and plenty of repeat business available. I suspect the reason behind their increased gross margins has been focus on increasing the franchises which is a nice high margin business as the store owners pay you for the materials, marketing, etc. Its a great model and one that does even better with more scale. The business has successfully grown free cash flow at around 1$ in 2008 to around 14$ in the past 12 months. This is pretty impressive for a simple business like greasy peperoni, tomato and flour.
Are there reinvestment opportunities?
They have paid out dividends in the recent years (a low yield) but have also been able to consistently hit around 50% ROIC numbers for the past 10 years or so. With more stores still to come, it doesn’t seem unlikely that this trend will not continue for the next decade although, it cannot be sustained forever.
Is there a risk of a blow up?
The business does tend to run with some debt which can juice returns. The interest coverage is over 4 and given there is little risk of generating decent cash flows, this shouldn’t be a huge risk. The Altman-z score is 3.68 so no immediate bankruptcy threat and the Beneish M score is -2.6 so not a likely fraud when it comes to the accounting.
From an operating point of view, they seem to have a good brand with continued increases in sales and a decent customer service reputation. Their business is simple which is also a bonus. Last time I checked, people have continued to like pizza and are willing to shell out some dough for a slice.
Is management sketchy?
They have made good steady growth in the number of franchised stores and have not increased the corporate owned stores. This is a good strategy as the franchise is a lighter capital business although the trick is picking your franchisees correctly.
In terms of capital allocation, the management team has been firing on all cylinders recently with a good history of share buybacks when there aren’t opportunities to reinvest the cash into new stores or products. They have also been growing the dividend over the past few years to a point where the quarterly is now higher than the total annual payout for the year in 2013 (4X in less than 10 years).
Does it have a moat?
The brand is pretty strong but it is just pizza. I would say that the fact that they are a recognized and trusted brand, they will have a pretty solid moat but they will have to continually invest strategically to protect it. They have a very good online ordering system which I believe is top tier. We’ll see how the competition heats up in the next few years.
Is it cheap?
Not cheap. Their price to sales is over 4 currently which is at an recent history high for the stock. The PE is just over 30 which is slightly higher than history and a little higher than current market multiples. The growth should compensate for some of this however. The high valuation does not bode well for effective use of cash flow in terms of buybacks and they have already grown margins by quite a lot. It may prove difficult to get the same improvements to the bottom line over the next 10 years compared to the last 10. That being said, the fundamentals continue to be strong and there is no reason to think there isn’t room for many more pizza places both in the US and in other markets.
This isn’t a cheap slice of fine Brooklyn style pie but this business does have potential to grow more into the future and validate the somewhat high price tag. If the company management continues to focus on shareholder return through steady growth in franchises and consistent growing dividends/buybacks then it seems very likely that you could get a nice return over the next decade. The key here is likely watching out for what their competitors do to erode their slice of the pie.
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BONUS: a PIE chart explaining the value of pizza