Domino's: Is it time to own a slice of this business?
Opdateret: 7. aug.
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 business. 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.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
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:
Domino's was founded in Michigan, USA in 1960, and it all started with one restaurant. Domino's now has around 19.800restaurants in 90 different countries. Domino's is primarily known for making pizzas, which can be delivered or picked up. Domino's generally doesn't offer dine-in experiences, which means that their stores don't require expensive restaurant facilities and staffing. Domino's is primarily a franchisor, as 99% of their 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 (33% of revenue in 2022), International franchise (6% of revenue in 2022), and supply chain (61%of revenue in 2022). Supply chain is a combination of dough manufacturing and supply chain 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.
Their CEO is Russell Weiner. He joined Domino's in 2008 and became the CEO in 2022. Before becoming the CEO, he held various positions in 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 directorsof The Clorox Company. He has been credited with running the "pizza turnaround" campaign, which became central to Domino's success. As a result, he was named Marketer of the Year in the restaurant category by Brandweek in 2010.During Russell Weiner's tenure in the U.S. business, retail sales grew from $3 billion to $8 billion, store count grew 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 as CEO so far. Nonetheless, he has vast experience in the company, and I particularly liked one quote fromthe Q4 2022 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. Hence, I feel confident with Russell Weiner moving forward.
I believe that Domino's has a strong brand moat. And I feel confident that Russell Weiner is the right person to continue Domino's growth. Now let us investigate the numbers to see if Domino's lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all the numbers being above 10% in 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 well above 40% 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 four years, but it is not something I would worry about as the ROIC is still above 40%. Hopefully, Domino's will manage to maintain a percentage above 40% 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 percentage growth year over year. It is curious that Domino's has had a negative book value for all ten years. The reason for this is that Domino's has utilized debt to repurchase shares. It might make sense if the stock is significantly undervalued and the debt has a low interest rate. However, I personally prefer to see a company reduce itsdebt, and I'm uncertain about my opinion on this strategy.
Finally, we will investigate 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. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected 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 increased since 2018. Free cash flow was slightly lower in 2022, which has been a challenging year for most companies. The challenging year of 2022 also impacted the levered free cash flow margin. However, the free cash flow yield indicates that Domino's is trading at a lower price than usual. We will discuss this further later in the analysis.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings.Doing the calculation on Domino's, I can see that Domino's has 10,82 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 keep me from investing in Domino's, it is something that I don't particularly like.
Based on my preliminary findings, I believe that Domino's could be an intriguing company. However, no investment iswithout 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 increasing. 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 for food and labor. Furthermore, Domino's delivery business has also been affected due to constrained budgets for households with relatively lower disposable income. These households have shifted from ordering delivery to cooking at home. Macroeconomics has also affected store openings due to challenges in the construction supply chain. 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. It is not only competition for customers but also for labor, such as delivery drivers. Furthermore, Domino's also faces competition from the supermarket industry due to the improvement of prepared food. Thus, competition could have a negative impact on Domino's operating results.
Domino's also has a lot of potential for growth. One growth catalyst is that Domino's has not yet reached its full store potential. Domino's has a plan to open more stores to drive revenue, and there is still plenty of room to grow their number of stores. Management believes that the U.S. has the potential for more than 8.000 stores, and currently Domino's has around 6.700 stores. In developed markets, Domino's currently has around 5.000 stores, and they believe there is potential for around 8.500 stores. However, it is the emerging markets that will truly increase the number of Domino's stores.Currently, Domino's has just under 4.000 stores in emerging markets, and management expects a potential of around 11.500 stores. Thus, Domino's still has plenty of room to grow in each of the three markets. More stores mean more fees for Domino's. Improving their "Piece of the Pie" loyalty program. Loyalty programs drive customer retention, which can help businesses generate revenue, increase referrals, and achieve overall growth. Thus, it is no surprise that management has emphasized the importance of the Piece of the Pie loyalty program for sustained growth. The Piece of the Pie loyalty program was introduced in 2015, with a focus on delivery. However, Domino's business has since changed, and they now generate almost half of their revenue from the higher-margin carryout business. Management wants to update its loyalty program to also focus on carryout customers. As a result, management believes that their revamped loyalty program will increase customer loyalty to Domino's. Shareholder-friendly. As I mentioned earlier when discussing the significant debt, Domino's has been utilizing 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 their shares outstanding from 55,737 million in 2013 to 36,387 million in 2022, which is a decrease of 34,7% in 10 years. Besides that, Domino's is also paying an annual dividend of $4,84 in 2023. Domino's has also outperformed the S&P 500, as $1.000 invested in Domino's ten years ago would have turned into $5.651 compared to $3.152 of the S&P 500.
All right, we have gone through the numbers, potential and risk regarding Domino's, and now it is time for us to calculate a price for Domino's. In order to calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 12,53, which is from 2022. I chose an estimated future EPS growth rate of 15% (Domino's has delivered 17% growth in the last 5 years, but 15% is the highest I use). I also estimated a future PE of 30 (which is double the growth rate, as the historical PE for Domino's has been higher). Additionally, we have already determined the minimum acceptable return rate to be 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $375,90. 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 $187,95 (or lower, obviously) if we use the Margin of Safety price.
Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 475 and the capital expenditures were 87. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you canexpect 70% of the capital expenditures to be used on maintenance. This means that we will use 61 in our further calculations. The tax provision was 121. We have 36,387 outstanding shares. Hence, the calculation will be as follows:(475 - 61 + 121) / 36,387 x 10 = $147,03 in Ten Cap price.
The last calculation is the Payback Time. I also described in "MY STRATEGY". With Domino's Free Cash Flow Per Share at 10,67 and a growth rate of 15%, if you want your investment to be recoveredin 8 years, the Payback Time price is $168,43.
Domino's is an interesting company with a strong brand moat. The CEO is new but has vast experience from Domino's, so it isn't something that I worry about. Domino's is facing some macroeconomic headwinds, and if things worsen, 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 shouldn't fare 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 plenty of room to increase their number of stores worldwide, which should enhanceprofitability. And what I didn't mention in the analysis is that Domino's is a sought-after franchise, as its high profitability makes it one of the best investments in the restaurant industry. Thus, I don't see anything that will prevent Domino's from growing. If I were to invest in Domino's, I would require a significant margin of safety due to its substantial debt. Hence, I will open a position if Domino's reaches the margin of safety price of $187,95. It probably won't reach that level, which means that I will most likely not end up owning Domino's.
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