Domino's Pizza (DPZ)

TOP CONTRIBUTORS

Vincent McPhillip

Domino’s Pizza is the number one pizza delivery company in the United States and is one of the most recognizable pizza brands in the world. On average, Domino's sells over one million pizzas every day across the globe ^[1], and covers ten million miles per week in pizza deliveries^[2]. At the end of 2007, there were 8,624 domestic and international locations- the vast majority of them franchised. In FY 2007, the company generated $1.4B in revenue and over $190M in operating income.

Domino’s faces several headwinds moving forward. Rising food and energy prices^[3], the housing slump^[4] and a weakening job market^[5] are taking a toll on restaurant spending ^[6] in its core domestic market; the company saw a 1.7% decrease in comparable sales in the U.S. in 2007 after a 4.1% decrease in 2006 as consumers reduced their spending on pizza^[7]. Rising food costs, especially the cost of wheat and cheese, have also cut into operating margins^[8]. In order to meet these challenges and revive sales growth the company is launching a new marketing campaign under the slogan “You Got 30 Minutes" with the hope that this national advertising effort will help take market share from smaller, local pizzerias. The company is also trying to offset a weak U.S. market by focusing on expanding its international operations which continued to produce positive sales growth throughout 2007.

Business Overview

Domino's was founded in Michigan by Tom Monaghan in 1960 at the end of FY 2007 the company operated over 8000 locations in all 50 states and 55 countries. The company focuses on two core strengths: high quality pizza and fast delivery. Domino's business model sits on three pillars: 1) low cost delivery-oriented store design , 2) franchising and 3) a vertically integrated supply chain ^[9]. The company operates in three segments: domestic stores, domestic supply chain and international.

Domino's revenue by segment^[10]

Domino's operating income by segment^[11]

Domestic Stores

About 90% of the company's 5,155 domestic stores are franchised^[12]. Domino's uses its company-owned stores as a testing ground for new products and technologies which may then be passed onto franchisees. Domino's generates income from company-owned stores in the form of store profits; income from franchisees mostly comes from royalties. Domestic stores had revenues of $552.6 million and operating income of $128.6 million during 2007^[13].

Domestic supply chain

This segment operates 17 supply chain centers that distribute food, equipment and supplies to almost all Domino's in the United States^[14]. A vertically integrated supply system provides two important advantages to Domino's and its franchisees. First, automatic delivery of raw materials cuts out a lot of the "back-of-store" activities letting store operators focus more on sales and customer service^[15]. Second, the vertically integrated supply chain lets Domino's leverage the purchasing power of thousands of company-owned and franchised stores nationwide which can help keep down food costs^[16]. In fiscal 2007, the domestic supply segment generated revenues of $783.3 million and operating income $49.7 million.^[17].

International

Domino's international segment consists of 3,469 franchised stores outside the United States.^[18] Domino's also has a supply chain in a limited number of its international markets; the company operates six supply chain centers which manufacture dough and distribute food and supplies. Domino's international operation have consistently grown as a percentage of company locations and systemwide revenues; in 2007, the international segment accounted for 41% of Domino's store sales worldwide^[19] (note: this figure represents percentage of total sales at company-owned and franchise stores and is not percentage of company revenue.) During 2007, Domino's international segment generated revenues of $126.9 million, of which approximately 52% resulted from the collection of franchise royalties and fees, accounting for 93% of the segment's $57.2 million in operating income^[20].

Domino's domestic and international store count^[21]

Domino's domestic and international store count^[22]

Trends & Forces

Rising Food and Energy Costs Shrink Margins

• Rising Food Costs: Domino's margins are dependent on food prices. In particular, the company is dependent on the price wheat (used to make dough) and cheese, two key ingredients of any pizza. Over the past few quarters the prices of these key inputs have risen significantly; in February 2008 a bushel of wheat cost $11.21 compared to $4.35 a year earlier^[23]. The company is also impacted by the price of corn, beef, poultry, other important ingredients for much of its menu.

• Rising Energy Costs: Domino's is also affected by the price of oil which has risen four-fold since 2001 with the price of gas rising more than two-thirds since last year alone.^[24] Oil is used to produce food, as well as to transport it all over the world. More importantly, the company covers over 10 million miles per week in pizza deliveries, making it a large consumer of gas. Furthermore, Domino's relies on diesel to fuel the delivery fleet of its domestic supply chain. Intense competition in the pizza delivery category limits the company's ability to pass rising food and energy costs onto customers; because of this, increased costs shrink margins and hurt profitability.

Same Store Sales: Can International Growth Offset a U.S. Slowdown?

Domino's operating income is dependent in part on royalty fees paid by franchisees. Because these royalties are a percentage of total revenues, same store sales are an important metric of Domino's performance. Increases in same-store sales translate to increased royalties which go right to the company's bottom line.

Domino's domestic same store sales have lagged while international stores continue to outperform^[25]

• U.S. consumer belt-tightening: Soaring food and energy prices^[26], the housing slump^[27] and a weakening job market^[28] have a negative impact on restaurant spending in Domino's core U.S. market^[29]. As consumers in the U.S. pare back discretionary spending, the company has seen two years of negative same store sales growth at its domestic stores. Although the company has a sizable international presence, it still generates 59% of revenue in the U.S. making it vulnerable to a continued slowdown in consumer spending.

• Strong International Growth: Domino's has a sizable international presence; 41% of retail revenues occur outside of the United States. In addition to developed markets like the U.K., Canada, South Korea and Australia, Domino's operates in fast growing emerging markets like India and Turkey. The company's international operations give it access to a rapidly growing global middle class and has consistently posted strong same-store sales growth:

New Marketing Campaign Aims to Drive Store Traffic

In fiscal 2007, Domino's hired a new advertising agency meant to lead the company's new marketing campaign and service message: "You've Got 30 Minutes." The "You've Got 30 Minutes" hopes to highlight the value of what pizza delivery really does for consumers – gives them free time. The campaign will generate customer awareness of the company's commitment to deliver a hot, fresh meal in about 30 minutes. Domino's strong national advertising presence may help it lure customers from smaller, local pizzerias; the company estimates that it has spend $1.4B over the last five years on branding and marketing efforts^[39].

Competition

Domino's competes in the QSR segment. The QSR segment of the food and beverage industry generated $440B in revenue last year alone. Most broadly, Domino's competes with other QSR's like McDonald's, Wendy's and KFC. More narrowly the company operates in the pizza delivery category which is comprised of Pizza Hut, Papa John's and thousands of smaller, local pizzerias. Pizza Hut, a division of Yum! Brands is the company's largest competitor with 12,877 stores worldwide generating $10B in system wide sales^[40]. Although Pizza Hut is the world's largest pizza chain by sales, Domino's actually delivers the most pizzas to homes and holds the title of the world's largest pizza delivery company^[41]. As of April 2008, Domino's held an impressive 19% market share in domestic pizza deliveries^[41]. This dominant market share arises from it's sizable advertising and marketing budget- a key competitive advantage.

Domino's holds a 19% share of U.S. pizza deliveries^[41].

References

1. ↑ Domino’s 2007 10-K Item 1 Business- Overview
2. ↑ Domino’s 2007 10-K Item 1 Business- Overview
3. ↑ The Boston Globe- Surging costs of groceries hit home
4. ↑ Bloomberg Case-Shiller Index Falls
5. ↑ NYTimes Unemployment Rising
6. ↑ Bitter taste: Food costs, less consumer spending hurting restaurants
7. ↑ Domino’s 2007 10-K Letter to Shareholders
8. ↑ Domino’s 2007 10-K Letter to Shareholders
9. ↑ Domino's 2007 10-K Item 1. Business- Overview
10. ↑ Domino's 2007 10-K Financial Highlights
11. ↑ Domino's 2007 10-K Item 1. Business- Overview
12. ↑ Domino's 2007 10-K Introduction- Domino's Pizza Business Model
13. ↑ Domino's 2007 10-K Item 1. Business- Overview
14. ↑ Domino's 2007 10-K Item 1. Business- Overview
15. ↑ Domino's 2007 10-K Item 1. Business- Competitive Strengths
16. ↑ Domino's 2007 10-K Introduction- Domino's Pizza Business Model
17. ↑ Domino's 2007 10-K Item 1. Business- Overview
18. ↑ Domino's 2007 10-K Item 1. Business- Overview
19. ↑ Domino's 2007 10-K Introduction- Financial Highlights
20. ↑ Domino's 2007 10-K Item 1. Business- Overview
21. ↑ Domino's 2007 10-K Introduction- Financial Highlights
22. ↑ Domino's 2007 10-K Introduction- Financial Highlights
23. ↑ The Boston Globe- Surging costs of groceries hit home
24. ↑ 'Most Worrisome Consumer Trends' http://www.bloggingstocks.com/2007/11/30/best-and-worst-of-2007-most-worrisome-consumer-trends/
25. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
26. ↑ The Boston Globe- Surging costs of groceries hit home
27. ↑ Bloomberg Case-Shiller Index Falls
28. ↑ NYTimes Unemployment Rising
29. ↑ Bitter taste: Food costs, less consumer spending hurting restaurants
30. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
31. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
32. ↑ Domino's Q1 2008 Earnings Call Transcript
33. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
34. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
35. ↑ Domino's Q1 2008 Earnings Call Transcript
36. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
37. ↑ Domino’s 2007 10-K Item 6. Selected Financial Data
38. ↑ Domino's Q1 2008 Earnings Call Transcript
39. ↑ Domino's 2007 10-K Item 1. Business- Competitive Strengths
40. ↑ Yum! Brands 2007 10-K Worldwide System Units p. 31
41. ↑ ^{41.0 41.1 41.2} Domino's Investor Presentation- April 2008