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 difficult competitive environment, you need to know how to pull the lid on yourself to create lasting competitive advantage. That’s what Domino’s Pizza has achieved by gaining market share on all sides and delivering shareholder returns of more than 1921% over the past decade (2012-2021).

Domino’s Pizza is the world’s leading franchise in the sale and delivery of pizzas and the second in the United States behind Pizza Huts. The group has more than 19,500 points of sale (only 2% directly owned and 98% franchise) in more than 90 countries. The number of points of sale has almost doubled over the last decade, especially internationally, where the growth dynamics (both in number of stores and in sales per store) are more sustained.

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

Source: Domino’s Pizza

The group claims 20% global market share in pizza-based fast food, 22% market share in the US and 31% market share specifically in the US home delivery market.

Source: Domino’s Pizza

The reasons for their success

Gastronomy lovers may not understand their success, especially when you know the recent successful launches of pizza burgers and pizza kebabs. So instead of being surprised, let’s try to understand the keys to their success.

Domino’s has succeeded where many have failed ie. creating an experience comparable to that offered by your local pizza maker, but much more efficient and therefore profitable. Their business model is fundamentally 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:

This efficiency draws the company today from a well-optimized process over time that has turned Domino’s restaurants into veritable small factories in force, delivering several pizzas per minute. The kitchens receive pizzas in a set of this kind. The pizza dough is frozen and the ingredients are prepackaged. Chefs are ingredient gatherers. All you have to do is add the ingredients and cook everything in seconds.

Domino’s worked on optimizing time on the principle of fast food, but also human staff. A maximum number of employees are allocated to assembling the pizza in the last minutes. The rest of their supply chain is robotic to the max.

In addition to its traditional catering business, Domino’s is sometimes presented as a digital pioneer because the group very early developed its online ordering and delivery solutions, among other technology-based customer loyalty programs. They turned quickly (and much better than the others) to home delivery and internet ordering. In fact, customers ordering on-site require employees to welcome them and take their order. Domino’s has successfully introduced online ordering to its customers. At Domino’s, more than one in two pizzas are ordered online, which is better than all their competitors.

Another important growth arm 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 will be profitable immediately and be able to pay back their initial investment as quickly as possible. If we look at the franchisees’ cash returns, they amount to between 25% and 50% depending on the point of sale. They thus take between 2 and 4 years to repay their investment. It is much better than the competition (McDonald’s, Burger King, etc.). In addition, Domino’s shares 50% of the profits from its “supply chain” subsidiary with its franchisees, increasing 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. Franchisees have an average of eight points of sale and are generally very loyal: 99% of contracts are renewed every year. For example, in 2021, 214 points of sale were opened in the United States compared to only 9 that were closed. In addition to having a loyal network of franchisees, this makes it possible to grow in volume (in number of restaurants and thus in revenue) without increasing the price of pizzas (this to remain competitive with direct and indirect competitors).

I especially appreciate Domino’s deployment strategy based on a fortress encircling the city to occupy all the space and optimize the density of routes, reducing the time and cost of deliveries for drivers. This concentration will stifle competition without causing cannibalization, that is when one Domino’s restaurant is in competition with another Domino’s restaurant. This is because over 90% of customers at a new Domino’s store have not bought Domino’s before. The company also ensures that franchisees own multiple restaurants in the same geographic area to improve relationships and avoid cannibalization.

Source: Domino’s Pizza

Last but not 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 collected their customers’ entire history, orders, payment history or even their sensitivity to advertising for twenty years, giving 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 onset of the Great Financial Crisis (2008-2009) took the helm of a dying Domino’s Pizza before setting in motion a masterful turnaround. In 2008, pizza tasted like cardboard. Customers had begun to lose interest in the chain. Sales had been declining since 2006. Patrick Doyle then arrives with much fanfare to change all that. Doyle has reviewed the marketing (emphasis on technology, revision of communication and supply, etc.) and financial management of the group (Domino’s follows a model that is well beyond its competitors, as we will see later in the article).

At the same time, when Patrick Doyle took over the company only a few months ago, a scandal broke out in the middle of the financial crisis: A video of two employees sneezing and spitting on pizzas created bad buzz on the Internet. The former CEO decides to quickly change the customer experience. He encouraged Russell Weiner of Pepsi to take the position of marketing director. They are redefining the guidelines of the strategy that has made Domino’s successful over the past 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 a campaign to apologize, called “Our pizzas stink” (literally: “Our pizzas stink”), 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 performed well in this position since 2018, though he lacks the brilliance of his predecessor.

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

Source: Zonebourse

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

On the financial side

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

In terms of revenue, we go from $1.68 to $4.36 billion, or a CAGR of 10%. Operating margins are completely stable (as is often the case in the QSR sector), but nevertheless significantly lower than at McDonald’s or Burger King).

Source: Zonebourse

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

FCF thus increases from 150 million in 2012 to 560 million dollars in 2022, i.e. an expansion of profits even more significantly than the expansion of revenue. This stems from a specific capital allocation as Domino’s is a “share cannibal“, i.e. a listed company that buys back its shares very aggressively.

Thus, over the 2012-2022 period, Domino’s generated $3 billion in FCF, but spent $5.2 billion on share buybacks (net of new shares issued in the stock option program). With $800 million in dividends paid out concurrently, Domino’s returned exactly $6 billion to its shareholders over the cycle, double its earning power.

First small observation so visible: all other things being equal, that is, assuming that everything continues at this rate, with a current market value of 13 billion, Domino’s is globally valued at 30 times profit.

In the short term (over the cycle in question), the strategy has been incredibly successful, with a market cap said to grow by 1921% between 2012 and 2021. The problem, however, is that it is never healthy to return more capital to your shareholders than you generates profits through operations. There over 2012-2022 is a $3 billion “gap” (3 billion in accumulated profits vs. 6 billion returned to shareholders, right?), filled of course with a corresponding increase in debt. This is where I think the music might not go on forever.

Source: Zonebourse

The situation was further eased by the very low interest rates, which made it possible to borrow at very low costs and thus increase arbitrage (the company had the intelligence to take on debt at low interest rates to buy back its shares). With the increase in interest rates and a now high leverage (net debt is now worth almost 6 times EBITDA), it is not certain that this situation can continue for long, in a world where debt is likely to be paid more expensively.

Especially since the competitive landscape has changed with the now ubiquitous Uber and Deliveroo types (as we said, Domino’s was a pioneer in technologies) providing access to an abundance of fast food offerings.

Although the story is not as idyllic as in 2009 at the bottom of the subprime crisis, when the possibilities of turning it into a masterpiece were great, there is still a small potential to continue opening sales points and optimize costs further, but I do not know. I don’t think we should expect the same growth as in the past.

Source: Domino’s Pizza

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

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

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