This week's post is a casual valuation of Domino's Pizza ($DPZ), a company that I'm sure doesn't need a long introduction, as most of you are familiar with it (or at least with the products it sells).
TLDR: It is a great business, but overvalued, despite the share price being down 40% vs. 2 years. ago.
The post will be divided into the following segments:
- Introduction
- # of stores
- How does Domino's Pizza make money?
- Historical financial performance & Balance sheet
- How can Domino's Pizza grow?
- The growth potential
- Returning cash to the shareholders
- Assumptions & valuatio
Introduction
Domino's Pizza was founded back in 1960, and since then, it has grown to become the largest pizza company in the world.
# of stores (locations)
Today, it has over 20,000 stores all over the world. What I found very interesting is the split of these locations (As of September 2023):
1. Company-owned locations
There are only 288 locations that are owned by Domino's Pizza (representing 1.4% of all locations).
This number is down from 384 back in 2015.
2. US locations
There are 6,474 US locations (representing 32.1% of all locations).
This is up from 4,816 back in 2015. This is an average growth below 4%/year.
3. International locations
There are 13,435 locations internationally (representing the remaining 66.5% of all locations).
This is up from 7,330 back in 2015, representing an average growth of 8%.
Conclusion:
- The management has no intentions of opening locations that will be owned by Domino's.
- There's limited growth that can be expected within the US
- The majority of the growth in terms of locations will be outside of the US.
How does Domino's Pizza make money?
Here's a split of the revenue:
- 61% Supply chain (Selling food, equipment & supplies to the franchisees)
- 13% U.S. Franchise royalties and fees
- 11% U.S. franchise advertising
- 8% U.S. Company-owned stores
- 7% International franchise royalties and fees
Although there are 2x more locations outside of the U.S., Domino's Pizza makes a lot more in revenue from the ones within the U.S.
The majority of the revenue is related to the supply chain, and the company has built infrastructure to support this, in the form of:
- 22 regional U.S. dough manufacturing and supply chain centers
- 2 thin crust manufacturing facilities
- 1 vegetable processing center
- 1 center providing equipment and supplies
- Over 1,000 tractors and trailers
Historical financial performance & Balance sheet
Domino's Pizza is one of the most stable companies margins-wise. Over the last decade, the operating margin was between 17% and 18%. I find this fascinating considering all the macroeconomic events that happened during this time frame.
Over the last twelve months, the total revenue was close to $4.5 billion, growing at around 5%/year. This is translating to over $800 million in operating profit.
On the balance sheet, the only thing that is worth noting is the debt of around $5 billion. In addition, the management has been doing an amazing job of optimizing the operating working capital. The receivables of $250 million and inventory of $60 million are incredibly low for a company of this kind (considering the LTM revenue of $4.5 billion and COGS of $2.8 billion).
How can Domino's Pizza grow?
One of the questions I'm always asking is, what does it take for this company to grow? How can the operating profit increase from $800 million to $1 billion, to $2 billion? Here are a few options, and my thoughts on each:
– New locations – The more locations there are, the more revenue, the more profit, right? Sounds simple. Well, if we take a look at the conclusion related to the locations above, it becomes clear that the growth from new locations will be limited. The company isn't opening new locations, the U.S. growth will be limited, and there's nothing the management can do to increase the demand for franchising internationally without sacrificing the margins.
– Selling more through existing locations – This is quite optimized as there's very little increase YoY that is not attributable to inflation. Considering the industry, it is unlikely that Domino's Pizza will come up with an incredible disruptive product that will blow your mind.
– Improve margin – As the operating margin has been between 17% and 18% for over a decade, it is unlikely that this is a lever the management can pull.
My conclusion is that Domino's Pizza will grow at a much, much slower pace than it had historically.
The growth potentialAs there are already more than 20,000 locations, the question is, how much room is there to grow? Let's take a look at the # of locations of other chains:
- McDonald's – 40,275
- Starbucks – 37,222
- Subway – 37,000
- KFC – 25,000
- Domino's Piza – 20,197
- Burger King – 19,789
One of the key assumptions for valuing the company will be the future revenue growth, which is correlated to the # of locations that are expected in 2, 5, and 10 years' time.
Returning cash to the shareholders
As the company is profitable, it is worth taking a look at the decisions the management has taken when it comes to the excess cash. One of the priorities seems to be returning cash to the shareholders.
Buybacks: There are almost 40% less shares outstanding vs. a decade ago
Dividends: The 2014 dividends were $1/share, in 2023, that's almost $5/share. This is definitely impressive growth, but the growth is slowing down. In 2015, the dividend grew 25%, followed by 23% in 2016, and it kept declining until now. In 2023, the dividend increased by 10%.Based on today's share price, the dividend yield is 1.4%.
Assumptions and valuation
Here are the assumptions that I use in the DCF model to value Domino's Pizza:
Revenue: 6% growth/year until year 5, then slowly decreasing to 3%. This is a combination of 2-3% location growth + inflation.
Operating margin: 18% (in line with the historical profitability)
Discount rate: 8% (WACC-based)After adjusting for the cash/debt on the balance sheet, and the equity options, the company is worth $9.6 billion ($274/share).
For comparison, the market cap today is $11.9 billion ($341/share).
Based on my assumptions, the IRR offered is 6.1%.
Valuation based on assumptions different than mine
For those that expect higher/lower profitability and/or revenue growth, below is a table with other scenarios related to the revenue and operating margin 10 years from now:
| Revenue/Op. margin | 16% | 18% | 20% | # of locations |
|---|---|---|---|---|
| 48% ($6.6b) | $184.7 | $230.0 | $266.7 | 24.5k (+21%) |
| 71% ($7.6b) | $223.1 | $274.4 | $316.5 | 28.3k (+40%) |
| 100% ($8.9b) | $271.5 | $330.3 | $379.5 | 33.1k (+64%) |
Note: The revenue growth is a combination of more locations + inflation.
For Domino's Pizza to be fairly valued today, it needs to increase its operating margin to 20% and double its revenue in 10 years' time.
As always, I appreciate you reading the post, and I'd love to hear your thoughts and feedback.
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