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Domino's Pizza: The King Of Financial Leverage

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Domino"s Pizza Restaurant. Domino"s delivers much than 1 cardinal pizzas a day.

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Investment Thesis

In general, PE strategies are celebrated for making a batch of money. I deliberation nan logic is nan action of finance companies and nan due usage of leverage. As an individual investor, it is difficult to use a backstage equity strategy, but I deliberation its finance capacity tin beryllium imitated successful nan publically traded banal marketplace pinch nan correct action of stocks.

I judge that Domino's Pizza (NYSE:DPZ) tin beryllium nan correct action of that kind. It is simply a high-quality business pinch a agelong runway for maturation and beardown competitory advantages successful nan quick-service edifice industry. The institution has consistently demonstrated its expertise to turn and grow its marketplace share, acknowledgment to its attraction connected innovation, operational excellence, and superior customer experiences.

And, nan company's unsocial financial building and superior allocation policy, which person been proven complete a agelong play of time, person brought awesome profits to shareholders. Despite nan long-time successful way record, nan marketplace is overestimating nan consequence of macroeconomic issues specified arsenic ostentation and changes successful user behaviour successful nan transportation market. As a result, I judge that nan institution is an charismatic finance opportunity pinch nan imaginable for important semipermanent growth.

Company overview

The institution is simply a starring subordinate successful nan highly competitory QSR industry, pinch a well-established marque and a loyal customer base. The institution provides its pizza by transportation aliases carryout service. According to the institution presentation, successful nan U.S. two-thirds of its gross comes from transportation and one-third from carryout. The institution tin besides beryllium characterized arsenic a franchise business. There are 19,519 stores worldwide, 98% of which are franchised stores. The institution has a beardown marque powerfulness worldwide pinch a agelong history and value products and services. Like I mentioned, nan number of stores reached complete 19,000 successful 2021, and they run successful complete 90 world markets. Its marque powerfulness is rather comparable to 2 typical American companies, Starbucks (SBUX) and McDonald's (MCD), each operating successful 83 and 119 world markets respectively

Global QSR Pizza Industry is simply a Large and Growing Market

According to nan institution presentation, nan size of nan world pizza manufacture is astir $120B, of which nan QSR pizza manufacture is astir $81b, accounting for astir 67.5% of nan total. The unit income of nan Domino marque are astir $17.8B successful 2021, holding a marketplace stock of astir 15% based connected nan world pizza manufacture and astir 22% based connected nan world QSR pizza industry.

The pizza manufacture is not a fast-growing section for illustration unreality aliases e-commerce, but it continuously shows a dependable maturation rate. The US market, wherever pizza transportation was introduced early, shows a debased single-digit maturation rate, while nan world market, which still has room for growth, shows a mid-single-digit maturation rate.

Although nan wide maturation rates of nan manufacture itself are not that precocious compared to nan tech sector, I judge that nan institution has nary problem successful realizing its early maturation imaginable supra nan manufacture average.

First, Domino's Pizza has a proven way grounds of delivering beardown financial performance, pinch accordant gross and net maturation complete nan past respective years. The institution has a well-defined maturation strategy that includes expanding its shop base, expanding its integer capabilities, and expanding its world footprint.

Second, nan pizza manufacture is fragmented. The sum of nan marketplace stock of nan apical 4 companies is astir 50% while galore independent and small-chain pizza restaurants operating alongside larger chains. This benignant of business makes a larger institution for illustration DPZ support beardown marketplace positions successful position of marque recognition, operational efficiency, exertion and innovation, economies of scale, and trading and advertising, which tin thief them to stay competitory and successful.

Competitive advantages: The institution has made its ain pizza ecosystem.

Domino's Pizza has been successful successful integrating and maintaining its worth chains. The institution has a worth concatenation that includes respective cardinal activities that are captious to its success, specified arsenic procurement, operations, marketing, and customer service.

First, nan institution procures earthy materials specified arsenic cheese, vegetables, and nutrient and provides them to its stores by nan Supply concatenation business segment. Its gross was astir $2,500 cardinal and accounted for astir 60% of nan full income successful 2021. It chiefly supplies to much than 7,000 stores successful nan United States and Canada and tin generates dependable rate flows pinch gross profit margins of astir 10%. The strategical use of franchisees is that not only they tin person value earthy materials steadily and efficiently, but besides nan institution provides them pinch profit-sharing agreements, further strengthening nan pizza ecosystem that it operates.

[Revenue and GP margins of Supply concatenation business segment]

2017 2018 2019 2020 2021 LTM
Revenue 1,739 1,943 2,105 2,417 2,561 2,703
Gross profit margins 11.2% 10.9% 11.2% 11.3% 10.4% 9.3%

Second, nan institution has a highly businesslike operations strategy that ensures nan speedy and accordant transportation of pizzas. The institution uses exertion specified arsenic GPS search and AI-powered transportation routing to guarantee that pizzas are delivered connected clip and successful bully condition. Due to its starring exertion and long-time operational efficiency, moving a Domino's shop is considered arsenic an charismatic business opportunity to imaginable franchisees. According to the institution website, much than 95% of Domino’s franchisees successful nan U.S. started disconnected arsenic part-time pizza makers aliases transportation drivers and they ain an mean of conscionable nether 7 stores. In addition, they must person astatine slightest 1 twelvemonth of acquisition moving arsenic a Domino’s wide head aliases supervisor to go an owner, further strengthening Domino's ain pizza ecosystem.

[Store economics]

Average play portion income (# of stores) EBITDA Margin
<$10,000 (46) -5.40%
$10,001-$15,000 (457) 5.40%
$15,001-$20,000 (1,156) 9.90%
$20,001-$25,000 (1,287) 12.30%
$25,001+ (2,439) 15.50%

Third, nan institution conducts an businesslike and sustainable trading activities. It runs a money called Domino's National Advertising Fund Inc that administers nan Domino's Pizza system's nationalist and marketplace level advertizing activities successful nan U.S. Each franchisee is mostly required to lend 6% of their unit income to money nationalist trading and advertizing campaigns. Expenses specified arsenic trading and R&D are much for illustration superior expenditures connected intangibles alternatively than one-time expenses. In 2021, it was astir $480 million, accounting for 10% of nan full sales. By efficaciously executing nan advertizing fund, nan pizza ecosystem has formed a virtuous rhythm building by giving backmost a larger worth of what was received.

The company's superior allocation argumentation is really superior successful maximizing shareholder's value.

The institution tin make dependable free rate flows pinch a capital-light business model. The franchising business exemplary allows nan institution to grow its footprint and make revenues without having to build and run its ain stores. And nan company's successful superior allocation argumentation has created plentifulness of rate to administer to shareholders, moreover aft investing for growth.

First, nan company's progressive distribution argumentation to shareholders tin beryllium recovered by looking astatine nan inclination of nan number of outstanding shares complete nan past decade. I compared nan institution to respective companies that are mostly considered to person nan expertise to make beardown rate flows and sound superior allocation policies. As shown successful nan array below, nan number of Domino's outstanding shares has decreased importantly done an progressive stock buyback policy, and only Apple (AAPL), nan world's No. 1 company, is comparable to nan institution successful position of nan alteration successful nan number of full outstanding shares.

The inclination of full shares outstanding

The comparison of DPZ's stock buyback trends pinch those of nan typical companies pinch nan expertise to make beardown rate flows and sound superior allocation policies (Seeking Alpha)

The company's agelong way grounds of distributing important rate to shareholders has been made imaginable not only by its competitory advantages, but besides by its unsocial attack to financial leverages.

In general, value companies prioritize maintaining a beardown equilibrium expanse to guarantee financial stableness and flexibility. However, nan institution has intentionally maintained a leveraged equilibrium expanse and has completed a number of recapitalization transactions alternatively than repaying a indebtedness successful rate since 1998.

Tickers LT Debt to Total Capital
DPZ 495.27%
YUM 384.97%
PZZA 146.42%
SBUX 137.08%
MCD 114.28%
QSR 76.34%
CMG 57.30%
DNUT 45.46%

Source: Seeking Alpha

As you tin spot successful nan array above, nan company's superior building is heavy leveraged compared to adjacent companies successful nan edifice manufacture moreover though nan institution uses a franchise exemplary and truthful does not person to ain its ain stores.

As is good known, nan leverage is simply a double-edged sword. It tin amplify some nan profits and losses. However, investors mostly person a antagonistic position connected it because astir of nan companies that usage leverage person damaged shareholders' interests successful nan agelong run.

But nan institution has stuck to its leveraged strategy for complete 20 years and been done awesome crises including nan 2008 world financial situation and nan caller 2020 pandemic. I deliberation nan company's successful financial strategy for specified a agelong clip intelligibly shows nan company's expertise alternatively than a specified coincidence. I person assurance that nan unsocial financial strategy will proceed to play a awesome domiciled successful maximizing shareholders' profits successful nan agelong run.

Valuation

I for illustration to usage nan earnings-yield method for valuation of companies pinch unchangeable rate flow. In my erstwhile articles I compared Amazon (AMZN) and Microsoft (MSFT) pinch U.S. Treasuries because I deliberation their rate travel stableness is arsenic precocious arsenic that of U.S. government.

But successful nan lawsuit of DPZ, I compared nan company's forecasted net output pinch BBB US Corporate Effective Yield because of its leveraged equilibrium sheet.

To cipher forecasted adjacent 5-year rate flows of nan company, I made nan assumptions arsenic follows.

First, nan company's income are expected to turn astatine a humanities level of astir 9.0% because nan QSR pizza manufacture is expected to stay unchangeable and large and growing.

Next, nan company's gross profit separator has shown mediocre capacity compared to nan past owed to precocious ostentation rates. The company's income connection recognizes nan costs of income successful U.S. company-owned stores and proviso concatenation segments, some of which are inevitably affected by nan inflation. I assumed that inflationary impacts would easiness going forward, resulting successful a costs building astatine nan humanities mean level. Operating expenses see wide administrative expenses and US franchise advertising. Franchise advertizing is nan aforesaid arsenic nan franchise advertizing revenues. The institution controls only wide administrative expenses. General administrative expenses are besides assumed to beryllium astatine nan humanities mean level. Based connected nan assumptions I made, nan company's EBIT separator will beryllium astir 17.0%.

Finally, I adjusted EBIT by capitalizing immoderate operating expenses because they are investments successful intangible assets, not one-time expenses. All trading expenses and 30% of wide administrative expenses were capitalized.

My valuation results are below.

(Unit: Million, %) LTM 2023(F) 2024(F) 2025(F) 2026(F) 2027(F)
EBIT 742 830 908 993 1,087 1,190
(+) General & Administrative 426 513 559 610 666 727
(+) U.S. franchise advertising 475 523 575 632 696 765
(-) General & Administrative Amortization (115) (119) (131) (143) (156) (171)
(-) U.S. franchise advertizing Amortization (356) (396) (438) (484) (533) (587)
EBIT, adjusted 1,172 1,351 1,473 1,609 1,759 1,925
Current Enterprise Value 17,947
Forward Earnings Yield 7.53% 8.21% 8.96% 9.80% 10.72%
BBB US Corporate Effective Yield 5.69% 5.69% 5.69% 5.69% 5.69%

Comparing nan adjacent year's net output pinch BBB US Corporate Effective Yield, I deliberation its existent valuation is charismatic to invest. Furthermore, pinch a semipermanent view, not conscionable nan adjacent year, I tin expect nan net output to turn to supra 10% astatine nan existent marketplace valuation complete nan adjacent 5 years.

Risks

The accelerated maturation of nan nutrient transportation marketplace is simply a emblematic threat to nan edifice industry. According to McKinsey & Company, nutrient transportation has go a world marketplace worthy much than $150 billion, having much than tripled since 2017. Many restaurants whose business was deed difficult during nan pandemic entered transportation apps, and they gave customers much wide nutrient choices via delivery. Furthermore, younger generations for illustration convenience and ready-to-eat meals, which poses a structural consequence to nan industry.

However, I don't deliberation nan accelerated maturation of nan transportation marketplace poses a large threat to nan company. First, nan existent transportation marketplace is not a sustainable business exemplary for edifice owners. According to McKinsey & Company, successful general, nan edifice business has a profit separator betwixt 7 to 22 percent but nan transportation level commissions are astir 15 to 30 percent, which is unsustainable arsenic transportation orders go larger. To unafraid a definite level of profits done delivery, group person to bid high-margin items specified arsenic vino aliases alcoholic beverages, but fewer group bid done delivery. During nan pandemic, they were forced to usage transportation apps, but arsenic things are backmost to normal, nan title for nutrient choices is going to ease.

Next, I deliberation pizza is difficult to win successful nan third-party transportation market. Delivery platforms are perpetually recruiting drivers to supply accelerated transportation services. And completing arsenic galore orders arsenic imaginable per transportation is nan measurement to maximize nan transportation driver's profit. However, pizza uses a different packaging method than different foods. It's difficult to ideate that pizza comes successful a transportation packaging container. And nan unsocial packaging utilized for pizza makes transportation drivers reluctant to process pizza orders because it takes up a batch of abstraction and makes it difficult to stack. So, successful nan lawsuit of pizza, pizza transportation platforms specified arsenic Domino's will beryllium superior to that of third-party transportation services.

In conclusion

I deliberation nan institution is simply a emblematic illustration of PE firms' choice. First, it operates successful a large and increasing market. Second, its expertise to prolong unchangeable rate flows makes it imaginable to usage precocious financial leverage. Third, pinch ample rate flows, nan guidance is eager to administer rate to shareholders.

Recently, DPZ banal value has declined owed to macroeconomic issues, but I spot this arsenic a bully finance opportunity. And if we tin support a semipermanent finance sky for illustration backstage equity firms, I judge we tin besides expect a bully consequence by investing successful nan company.

This article was written by

Taron Kwak floor plan picture

Hello, I americium from South Korea and a CFA charter holder since 2018. My finance accuracy is worth investing. Thank you.

Disclosure: I/we person nary stock, action aliases akin derivative position successful immoderate of nan companies mentioned, but whitethorn initiate a beneficial Long position done a acquisition of nan stock, aliases nan acquisition of telephone options aliases akin derivatives successful DPZ complete nan adjacent 72 hours. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga



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