Multibagger Stories: Domino’s Pizza

Foodservice is known to be a highly competitive market with very low switching costs for consumers who can easily hesitate and switch between a burger, pizza or sushi. So, in this challenging competitive environment, you need to know how to pull the cover your way to create lasting competitive advantages. This is what Domino’s Pizza has achieved by gaining market share on all fronts and delivering a return to shareholders of over 1921% over the past decade (2012-2021).

Domino’s Pizza is the world’s leading pizza franchise and the second largest in the United States after Pizza Huts. The group has more than 19,500 points of sale (only 2% directly owned and 98% franchised) in more than 90 countries. The number of stores has almost doubled in the last decade, particularly at an international level where the growth dynamics (both in number of stores and in sales per store) is more sustained.

The company estimates the pizza market at $120 billion annually. Two-thirds would be captured by fast food (QSR) distributed 50% in the United States and 50% in the rest of the world. It’s a very fragmented market, but half of American sales are made by the top four restaurant chains, of which Domino’s is obviously one.

Source: Domino’s Pizza

The group has a global market share of 20% in the pizza-based fast food sector, a market share of 22% in the United States and a market share of 31% specifically in the home delivery market in the United States .

Source: Domino’s Pizza

The reasons for their success

Gastronomy lovers may not understand their success, especially when you know about the latest successful launches of pizza-burgers and pizza-kebabs. So instead of being blown away, let’s figure out the keys to their success.

Domino’s has succeeded where many have failed, which is by creating an experience comparable to that offered by the pizza chef in your neighborhood, but resulting much more efficient, and therefore profitable. Their business model is basically simple: “Domino’s restaurants prepare and serve quality pizza at a competitive price with easy access to ordering and efficient service, enhanced by their technological innovations”. We will see in detail what this means:

Today, the company draws this efficiency from a process that has been well optimized over time, which has made Domino’s restaurants real small power factories that deliver several pizzas per minute. The kitchens receive pizzas in a sort of kit. The pizza dough is frozen and the ingredients pre-packaged. Cooks are assemblers of ingredients. All you have to do is add the ingredients and cook everything in seconds.

Domino’s has worked on optimizing time on the principle of fast food but also human personnel. A maximum of employees are destined for the pizza assembly in the last few minutes. The rest of their supply chain is robotic to the max.

In addition to its traditional restaurant business, Domino’s is sometimes touted as a digital pioneer because the group developed its online ordering and delivery solutions, among other technology-based customer loyalty programs, early on. They quickly (and much better than most) switched to home delivery and Internet ordering. Indeed, customers who order on the spot require employees to greet them and take their order. Domino’s has successfully introduced online ordering to their customers. At Domino’s, more than one in two pizzas are ordered online, which is better than all of the competition.

Another important growth lever comes from the franchisees themselves. You should know that people who want to open a QSR (Quick Service Restaurant) are looking to open a restaurant that is profitable immediately and is able to pay back the initial investment as quickly as possible. If we look at franchisee cash returns, they amount to between 25% and 50% depending on the outlet. Therefore, they take 2 to 4 years to repay their investment. It is much better than the competitors (McDonald’s, Burger King, etc). Additionally, Domino’s shares 50% of its supply chain subsidiary’s profits with its franchisees, which increases their satisfaction and brand loyalty. Furthermore, restaurateurs do not have the right to open franchises of other brands if they have one or more Domino’s outlets. Affiliates have an average of eight points of sale and are generally very loyal: 99% of contracts are renewed every year. For example, 214 stores opened in 2021 in the United States compared to only 9 that were closed. In addition to having a loyal network of franchisees, this allows for growth in volume (in number of restaurants and therefore in turnover) without increasing the price of pizzas (this is to remain competitive with direct and indirect competitors).

I particularly like Domino’s implementation strategy based on a fortress that surrounds the city in order to occupy all the space and optimize the density of the routes, which reduces delivery times and costs for the drivers. This concentration comes to stifle competition without producing cannibalization, i.e. when a Domino’s restaurant competes with another Domino’s restaurant. That’s because over 90% of customers at a new Domino’s store hadn’t bought Domino’s before. The company also ensures that franchisees own multiple restaurants in the same geographic area in order to improve relationships and avoid cannibalization.

Source: Domino’s Pizza

Last, but not the least, which explains the company’s success is its technological advancement. Domino’s is constantly innovating, whether it’s using algorithms to make regional pricing decisions or tracking drivers to shorten delivery times. Their Pulse Pos system has been collecting all the history of their customers, orders, payment history or even their sensitivity to advertising for twenty years, which gives them a significant advantage.

Source: Domino’s Pizza

The genesis of success

These successes are largely due to the charismatic ex-CEO Patrick Doyle, who at the turn of the great financial crisis (2008-2009) took the helm of a moribund Domino’s Pizza before piloting a masterful turnaround. In 2008 the pizza tasted like cardboard. Customers were beginning to lose interest in the chain. Sales had been down since 2006. Patrick Doyle then arrives with great fanfare to change all that. Doyle has completely revised the marketing (emphasis on technology, communication and offer review, etc.) and the financial management of the group (Domino’s follows a model that is quite different from its competitors as we will see later in the article).

At the same time, when Patrick Doyle took over the company for only a few months, a scandal broke out in the midst of a financial crisis: a video of two employees sneezing and spitting on pizzas caused an ugly stir on the Internet. Former CEO decides to quickly change the customer experience. He brought in Russell Weiner of Pepsi to take over as director of marketing. They redefine the guidelines of the strategy that has made Domino’s success over the last ten years. The main priorities are to improve the taste of the pizzas and make the brand loved by the general public. They then run an apology campaign, dubbed “Our pizzas make suck” (literally: “Our pizzas suck”), highlighting customer complaints before claiming that everything has changed. Customers appreciated the honesty. Then they came up with new recipes. The success we know today follows.

Patrick Doyle has since been replaced by Richard E. Allison Jr. who has been doing well in this position since 2018 even though he lacks the brilliance of his predecessor.

In addition to dividends, this extremely well-inspired leadership led to a nearly 3,500% increase in the stock market over the decade 2010-2020.

Source: Zoneborse

If you had bought $10,000 worth of Domino’s Pizza stock at the low point of the subprime crisis, in March 2009, you would have achieved a performance of 21,645% through the end of 2021, and your initial investment would have become $2,174,600. The value more than deserves the title of multibagger.

On the financial side

As usual, we rely on long cycles because we are investors first. So let’s take a step back. The period examined corresponds to the last ten financial years, from 2012 to 2022.

In terms of revenues, it went from $1.68 billion to $4.36 billion, or a CAGR of 10%. Operating margins are perfectly stable (as is often the case in the QSR sector), but still significantly lower than McDonald’s or Burger King).

Source: Zoneborse

The business model is remarkably capital intensive and, as a result, cash generation is bloated. As proof, the cash profits (Free Cash Flow) and the net results are practically the same.

The FCF thus increases from 150 million in 2012 to 560 million dollars in 2022, which is an expansion in profits even more marked than the expansion in revenues. This comes from a particular capital allocation, Domino’s being a “share cannibal“, i.e. a publicly traded company that buys back its shares very aggressively.

Over 2012-2022, Domino’s thus generated $3 billion in FCF but spent $5.2 billion on share buybacks (net of new shares issued in the stock option program). Because $800 million in dividends were distributed in parallel, Domino’s returned exactly $6 billion to its shareholders in the cycle, or double its earning capacity.

First small observation so visibly: all other things being equal, ie assuming that everything continues at this pace, with a current market capitalization of 13 billion, Domino’s is globally valued at 30 times its profits.

In the short term (during the cycle in question), the strategy has been incredibly successful, with the market capitalization reported to have grown by 1921% between 2012 and 2021. However, the problem is that it is never healthy to give back. more capital to its shareholders rather than generating profits through operations. There is a $3 billion “gap” over 2012-2022 ($3 billion in cumulative earnings versus $6 billion returned to shareholders, isn’t it ticking?), filled of course by an equivalent increase in debt. This is where I think the music may not last forever.

Source: Zoneborse

The situation was further facilitated by the very low rates which made it possible to borrow at very low cost and therefore to enhance arbitrage (the company had the intelligence to borrow at low rates to buy back its shares). With interest rate hikes and a now high level of financial leverage (net debt is now almost 6 times EBITDA), this situation may not necessarily continue for long, in a world where debt risks being paid more expensively .

Especially since the competitive situation has changed with the now ubiquitous applications such as Uber and Deliveroo (as we said Domino’s was a pioneer in technology) which give access to a plethora of fast food options.

Even if the story is not as idyllic as it was in 2009 at the end of the subprime crisis when the opportunities to make a masterpiece were great, there is still some potential to continue opening stores and further optimize costs, but not I don’t think we should expect the same growth as in the past.

Source: Domino’s Pizza

Domino’s is an extraordinary story of organic growth through masterful management, marketing and financial strategy.

To complete the reading, I invite you to read the other stories on multibaggers in this series of articles dedicated to them (“multibagger stories”):

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