Domino's: Is it time to own a slice of this business?

Domino's has consistently achieved a fantastic return on invested capital (ROIC) over the years. Furthermore, Domino's is a market leader in the quick-service restaurant pizza industry. I prefer companies that consistently deliver a high return on invested capital, and I also prefer market leaders. Thus, it is about time that I take a closer look at Domino's.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own shares in Domino's.If you would like to view the stocks in my portfolio or if you are interested in copying my portfolio, you can find instructions on how to do so here. I don't own any stocks in any competitors of Domino's either. Thus, I have no personal stake in Domino's. If you are interested in investing in Domino's, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $50.

The Business

Domino's was founded in Michigan, USA in 1960, and it all started with one restaurant. Domino's now has around 20.600 restaurants in 90 different countries. Domino's is primarily known for making pizzas, which can be delivered or picked up. Domino's generally does not offer dine-in experiences, which means that their stores do not require expensive restaurant facilities and staffing. Domino's is primarily a franchisor, as 99% of its global stores are owned and operated by independent franchises. As a franchisor, Domino's generates its revenue through royalties and fees from franchises, sales of food, equipment, and supplies to franchises, and through its company-owned stores. Domino's has three business segments: U.S. stores (32% of revenue in 2023), International franchise (7% of revenue in 2023), and supply chain (61% of revenue in 2023). Supply chain is a network of dough manufacturing and distribution centers that sell food, equipment, and supplies to franchises. Domino's franchises are not obligated to obtain food and supplies exclusively from Domino's, but they choose to do so because it is efficient, convenient, cost-effective, and ensures consistency. Regarding U.S. stores, Domino's receives a 5,5% fee on sales, as well as certain technology fees. It is a bit different with international franchises, which pay a 3,0% fee on sales, but are also required to pay an initial one-time franchise fee as well as additional franchise fees upon opening new stores. Domino's is the largest pizza company in the world, and the brand is one of the most widely recognized consumer brands globally. Thus, Domino's has a strong brand moat.

Management

The CEO is Russell Weiner. He joined Domino's in 2008 and became the CEO in 2022. Before becoming the CEO, he held various positions at Domino's, such as COO, President of the Americas, and Chief Marketing Officer. Prior to joining Domino's, Russell Weiner oversaw Pepsi's North American cola business. He holds a Bachelor of Arts degree in Government from Cornell University and an MBA in Marketing and International Business from New York University's Stern School of Business. Besides serving on the board of directors at Domino's, he also serves on the board of directors of The Clorox Company. He has been credited with running the "Pizza Turnaround" campaign, which became central to Domino's success. As a result, Russell Weiner was named Marketer of the Year in the restaurant category by Brandweek in 2010. During his tenure in the U.S. business, retail sales grew from $3 billion to $8 billion, store count increased by 25%, and market share doubled. Russell Weiner is still new to his role as CEO, and it is not fair to judge him based on his performance in this position thus far. Nonetheless, he has vast experience in the company, and I particularly liked one quote from a previous earnings call, in which he said, "Our system understands that to be the best, you need to beat the best, even when the best may be yourself." It indicates that Russell Weiner won't rest on his laurels but will continue to drive the innovation in Domino's that he is known for. Therefore, I feel confident about Russell Weiner moving forward.

The Numbers

The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history where all figures exceed 10% each year. These numbers are certainly encouraging. Domino's has delivered some of the best Return on Invested Capital (ROIC) that I have ever seen. The requirement is a return on invested capital (ROIC) above 10% every year, but Domino's has consistently delivered a ROIC above 50% every year in the last ten years. You don't see many companies that manage to deliver such a high return on invested capital (ROIC). ROIC has dropped slightly in the last two years, but it is not something to worry about as the ROIC is still above 58%. It is encouraging that Domino's managed to increase ROIC in 2023 compared to 2022. Hopefully, Domino's will manage to maintain a percentage above 50% in the future.

The following numbers represent the sum of the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. It is curious that Domino's has had negative equity for all ten years. The reason for this is that Domino's has used debt to buy back shares. It might make sense if the stock is significantly undervalued and the debt has a low interest rate. Domino's equity has improved in the past two years, which is encouraging because debt comes with higher interest rates in 2022 and 2023. This improvement could suggest that Domino's hasn't utilized as much debt in the past two years.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Domino's consistently generates a positive free cash flow each year, which is always a positive sign. It is also encouraging to see that free cash flow has reached a higher level since 2018. Free cash flow was slightly lower in 2022, which has been a challenging year for most companies. Free cash flow increased in 2023 but has not reached the level from 2021. The challenging year of 2022 also impacted the levered free cash flow margin. Levered free cash flow margin increased in 2023 but has not yet reached the levels seen from 2019 to 2021. The free cash flow yield is slightly below the ten-year average, indicating that the shares are not trading at a discount. However, we will revisit this point later in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Upon calculating Domino's financials, I can see that Domino's has 9,5 earnings in debt. It is much more than I would like to see, but not surprisingly, Domino's has benefited from the low interest rates and used debt to buy back shares. While it won't necessarily deter me from investing in Domino's, it is something that I don't particularly like.

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Risks

Based on my preliminary findings, I believe that Domino's could be an intriguing company. However, no investment is without risk, and Domino's also has its share of risks. The most obvious risk is debt. In his book "Rule #1 Investing," Phil Town mentions the following about debt: "A business that carries a significant amount of debt compared to its income faces an uncertain financial future." "If there are any problems with the economy, a business with a significant amount of loans might be in big trouble". As an investor, I dislike unpredictability. Although I don't believe that Domino's will go bankrupt, I am concerned about companies with significant debt. I believe that Domino's should focus on paying off some of their debt, especially now that interest rates are high.

Macroeconomics. Domino's is affected by various macroeconomic factors. Some of the factors contributing to this issue include staffing shortages and a high inflationary environment affecting food and labor. In its annual report, Domino's mentions that they anticipate these macroeconomic factors may continue. There have been significant increases in food costs and labor costs, which have impacted Domino's profitability and could further impact that of its franchisees. These factors could also affect the opening of new U.S. and international franchised stores and adversely influence Domino's operating results. Furthermore, Domino's delivery business has also been affected by constrained budgets for households with relatively lower disposable income. These households have shifted from ordering delivery to cooking at home.

Competition. In their annual report, Domino's mentions that the quick-service restaurant pizza business is highly competitive. Domino's competes against regional and local companies, as well as national chains, in each country. Domino's also mentions that they are competing for labor, such as delivery drivers, and that this competition has substantially increased as order and delivery aggregators have grown in size and scale. Furthermore, Domino's also faces competition from the supermarket industry due to the improvement of prepared food. Thus, Domino's competes for both customers and labor, and also competes against other quick-service restaurants and the supermarket industry. If Domino's is not successful in this competition, it will affect its operating results.

Reasons to invest

There are plenty of reasons to invest in Domino's. One reason is that Domino's has ambitious growth targets. Domino's believes that it has more room to grow. Domino's is aiming for a 7% or more growth in global retail sales, which is equivalent to integrating a top-10 U.S. restaurant chain into Domino's global business within the next five years. Management has been very clear that the 7% growth in global retail sales is the minimum target, and they intend to exceed it. Domino's aims to open 1.100+ net new stores annually worldwide, indicating their goal to open at least 5.500 additional stores over the next five years. As of the end of 2023, Domino's had 20.591 stores globally, indicating a significant increase in store count. Domino's has stated that its operating income will grow at 8% or more over the next five years, indicating its intention to increase profits at a faster rate than sales. As with sales growth, management has been very clear that 8% is the minimum target, and they intend to achieve higher growth in operating profit.

Domino's Reward. Loyalty programs drive customer retention, which can help businesses generate revenue, increase referrals, and achieve overall growth. Domino's launched its new loyalty program, Domino's Rewards, in September 2023, which is an enhanced version of the previous loyalty program called "Piece of the Pie." The Domino's Rewards program is off to a great start, enrolling 2 million new members since September, ending 2023 with approximately 33 million active members. Domino's has experienced more redemptions than ever before, as customers are engaging more with the program. To attract customers to Domino's Rewards, Domino's launched one of the most innovative promotions in its history: Emergency Pizza. To qualify for a free Emergency Pizza on a future purchase, customers need to be enrolled in Domino's Rewards. Emergency Pizza drove incremental orders and helped jumpstart the launch of Domino's Rewards. Hence, the new and improved loyalty program is off to a good start and could benefit Domino's in the long term.

Domino's is shareholder-friendly. As mentioned earlier in the discussion about the significant debt, Domino's has been using debt to repurchase shares. You may or may not like that strategy, but it has resulted in some good shareholder returns. Domino's has decreased its shares outstanding from 55,251 million in 2014 to 34,726 million in 2023, which represents a decrease of 37,2% over10 years. Besides that, Domino's is also paying an annual dividend of $6,04 in 2024 and has grown its dividend by a 19,7% compound annual growth rate (CAGR) over the past ten years. Domino's has also significantly outperformed the S&P 500 over the past 10 years.

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Valuation

Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.

The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 14,66, which is from the year 2023. I have selected a projected future EPS growth rate of 7,5%. Finbox expects EPS to grow by 7,5% in the next five years. Additionally, I have selected a projected future P/E ratio of 15, which is double the growth rate. This decision is based on Domino's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $112,03. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Domino's at a price of $56,02 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 591, and capital expenditures were 105. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 74 in our calculations. The tax provision was 133. We have 34,726 outstanding shares. Hence, the calculation will be as follows: (591 – 105 + 133) / 34,726 x 10 = $178,25 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Domino's free cash flow per share at $13,92 and a growth rate of 7,5%, if you want to recoup your investment in 8 years, the Payback Time price is $156,32.

Conclusion

Domino's is an intriguing company with a robust brand moat. The CEO is new but has vast experience from Domino's, so it isn't something that worries me. Domino's is facing some macroeconomic headwinds, and if conditions deteriorate, it could have a lasting impact on the company. Domino's will always face competition, but since they have been in business for over 60 years, it is not something I worry too much about. However, I do worry about debt. While their strategy could make sense in a low-interest environment, it may not perform well in a high-interest environment. If management prioritizes paying off debt, it will affect EPS moving forward, which could potentially have a negative impact on the share price. Nonetheless, Domino's has big ambitions to grow sales, stores, and operating income over the next five years. They might succeed as Domino's is a sought-after franchise, given its high profitability, making it one of the best investments in the restaurant industry. Thus, I don't see anything that will prevent Domino's from growing. Their new loyalty program is off to a good start and could be something that will benefit Domino's in the long term, as loyalty programs typically help companies achieve overall growth. Finally, Domino's is very shareholder-friendly as it has reduced its shares outstanding by more than 37% in the past ten years, while growing its dividend by an average of 19% per year. I would like to buy shares in Domino's because I appreciate its business model, growth potential, and shareholder-friendly approach. However, for me to buy shares, the price will need to be below $312, which is the intrinsic value of the Payback Time price.

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