Domino's Pizza -- Last Bite
Finishing my take on DPZ by looking at how financial and physical engineering are the keys to the future of the Pizza Giant.
It’s time for my final wrap on my write up of the business of Domino’s Pizza. As you can see by the image below, it’s going to talk a bit about the future of the Pizza industry and how Domino’s is leading the pack. First though, it’s important to review what we’ve learned about the business, and then look at some of the financials that have underlaid the meteoric rise in it’s share price.
In the first two parts of our write up we focused on a key few elements of the core business of Domino’s:
It’s a franchise model which focuses on low cost of entry for franchise ownership
It’s low cost model allows it to require that all prospective owners have real world experience operating a Domino’s as either a supervisor or manager
In it’s franchise fee structures, it has ‘buckets’ to pass the corporate spend on technology, sales and marketing, and costs of food down to the franchise level. This creates a very efficient business structure for the public parent company.
Delivery is a key element of the business, but retaining drivers is becoming more difficult in the world of food delivery platforms
It pushes more stores over better stores in an attempt to improve delivery times and order quality
The low costs of Pizza, and it’s portability allow it to offset the expense of delivery and still maintain nice margins.
E-Ordering is also driving the costs of delivery down by giving the franchises better visibility into tips and lowering the wages it pays to cover mandated minimums
One thing which we won’t discuss in the this write up is the international business. That is because the international business is a different model. It’s a master franchise model which allows for investment groups and large financial partners to take the brand and bring it to a new market. International is certainly one growth avenue for the company, however for simplicity sakes I’d prefer to focus on the core business.
In 2008 Domino’s Stock Price was languishing at less than $4 per share. Today it currently sits at $400. A 100 bagger! However the success of it’s stock price isn’t exclusively the result of the business performance. Financial engineering has certainly played a part.
Here is a snap shot (via Morningstar) of the companies 10 year financials. Certainly it’s done a great job at increasing it’s income. Notice too it’s share count. Since 2011 the company has bought back 1/3 of it’s outstanding shares. How has it been able to do that?
Here is a look at key ratios of financial health. These are percentages, not dollars. Notice Long-Term Debt. Consistently the business has run Long-Term Debt at around 300% of the value of the assets on it’s balance sheet. To be fair, Domino’s is a very asset light model because it’s the franchisee’s which own most of the assets (stores, fixtures, etc.).
So what management has done is they’ve taken a franchise model, built in the capex, cost of revenues and op-ex as a pass down to the franchisee’s, and added financial leverage via low interest debt (thanks to historically low rates) on the profits knowing that consistently they will earn a certain amount depending on store count. They’ve used the leveraged profits to both reinvest in the business AND buyback a ton of shares.
However as the share price increases, in my opinion it’s more and more unlikely that the company will be able to sustain the leverage they’ve applied to generate such a high return for investors. In fact they’ve significantly lowered their leverage over the past 2 years. Whether this is a trend that continues remains to be seen, I believe it will.
Then what’s the bull thesis for a highly leveraged business that’s probably used up all the leverage it can handle? In short, technology.
Domino’s CEO reportedly once said that Domino’s is really a tech company that sells Pizzas.
How is Domino’s using technology to drive growth?
Here are some excerpts from a WSJ interview with the CEO. First he talked about Dom which is Domino’s AI Phone Chatbot:
“We're looking at "Dom" as a way to, first and foremost, answer every phone call. On the peak periods of our business, Friday nights and Saturday nights, we are missing some business because we're just so busy we're not answering all the phones. It's also going to allow us to do a better job of offering our customers relevant products and frankly, over time, will give us an opportunity to drive [bigger orders]. With our digital ordering platforms, we can test and build those things over time. It's very difficult to do that across tens of thousands of customer service representatives.”
In addition to AI, Domino’s is tapping into big data to help write it’s menus:
“We look at what customers choose to purchase from us over time, and we're tweaking the menu, adding things, taking things off constantly, based on those demand patterns over time. We launched a line of artisan pizzas, which we all thought tasted great. But the demand wasn't there, and so we pulled them off the menu. Customers told us that they really wanted the option of ordering salads, but didn't necessarily care for our salads. So we completely revamped and relaunched a line of salads.”
Robot Assisted Pizza Makers is another opportunity for Domino’s to leverage technology:
“We've been speeding up the process of cooling dough down. Just like if you make dough at home, when you mix the flour, water, oil, salt, everything together, that dough comes out of your mixer warm. Well, it comes out of ours warm as well. We've been installing [automated chillers] in our supply chain centers to do that faster and more efficiently. We bring fresh dough into our stores, and we make to order every pizza that we send out to our customers. That's the last thing I want to do, is have robots make pizzas. We'll certainly drive more automation in our supply chain centers, and there's AI that we can bring into our stores for things like labor scheduling. But wow, I really want to keep the magic of that pizza making. A third or so of our business is customers coming in and picking their food up. There are many things that we can be more efficient at in our stores before we think about having a robot make our food.”
On top of these tech innovations, Domino’s has recently announced autonomous delivery service in Houston via Nuro. According to Domino’s and Nuro, the R2 (the vehicle) is the first to ever receive regulatory approval. Currently it’s only being used by one store. However it’s definitely a big deal as delivery is one of the biggest expenses for Domino’s franchisees. It also provides what may be a clue as to why Domino’s wants to expand it’s store footprint. Having stores close to the neighborhoods they serve, makes autonomous a more realistic option. Lower distances combined with lower speed neighborhood streets, create the ideal situation for deploying nascent autonomous technology.
So after writing these 3 articles, here is my take on the company:
Don’t expect the blazing growth that was seen over the past 4 years in the stock price. The balance sheet won’t let them do that.
Do expect good management to continue to leverage technology and scale to generate modest growth on the top line and potentially significant improvements on the bottom line.
Warren Buffet has long advocated buying wonderful businesses at fair prices. By my judgement, Domino’s fits the bill. I think it’s a great name for every investor to have on their watchlist.