Domino’s Pizza: Q1 Results Likely To Disappoint (NYSE:DPZ)

Investment Conclusion

Domino’s Pizza (NYSE:DPZ) is scheduled to report F1Q2022 earnings on April 28, 2022, before the market opens. The average consensus revenue and earnings per share estimates for the quarter are ~$1.03 billion and $3.09. Based on continued headwinds associated with the U.S. business, we expect relatively muted first quarter growth in revenues and earnings.

To be specific, the labor shortage, including driver scarcity, that drove a demand and supply mismatch, with the company having to limit service over the fourth quarter, likely persisted over the first quarter. In addition, the absence of the stimulus package and unemployment benefits which fueled customer demand last year will also reflect in a weaker top-line. Moreover, given that commodity cost inflation remained a feature during the first quarter, overall margins will probably be impacted, despite some changes in pricing enacted in January and March. Given the scenario, although we anticipate improvement in the international business, which will counter some part of the potential weakness in domestic financial outcomes, earnings growth on an annualized basis will probably come in lower than that evidenced over recent years, in our opinion.

Beyond the first quarter, we expect DPZ’s U.S. business to improve somewhat towards the back half of the year, as labor conditions ease, driven by initiatives implemented by the company as well as an increase in availability of relevant talent. In addition, growth in the foreign business is likely to accelerate propelled by the further relaxing of pandemic restrictions across numerous countries, in particular in regions where a majority of DPZ’s sales are derived from dine-in transactions. However, margins are likely to suffer led by persisting inflationary pressures in the U.S., and exacerbated by higher commodity costs in international territories due to the Ukraine war. Overall, although we expect revenue leverage from rising retail sales to mitigate some contraction in margins due to inflation, growth in earnings and free cash flows is likely to decline on a year-over-year basis, over the short-term, in our judgment.

Over the long-term, the international business will drive most of DPZ’s revenue growth, through a substantial increase in the store count as well as significant same-store sales growth, leading to dramatic upsurge in retail sales. Domestically, we expect relatively slower revenue growth, with footprint expansion driving most of the advance in retail sales, and same-store sales growth remaining tepid. Nevertheless, based on dramatic success in international markets, DPZ will handily achieve its two to three year retail sales growth target of ~6% to ~10%, in our assessment. In addition, based on our longer-term expectations of lower commodity costs and no shortage of labor, as well as improvements in operations, and economies of scale and scope related to corporate spending, the digital platform, and advertising, we anticipate significant margin expansion. The revenue leverage from the potential sharply higher retail sales will come on top of the opportunities for margin expansion described above, driving further operating leverage. Overall, the anticipated dramatic upsurge in retail sales and margins will reflect in considerable escalation in profits and free cash flows on a secular basis, in our opinion.

Although, DPZ is likely to encounter near-term headwinds, we remain upbeat on the firm on a long-term basis. Given business dynamics, we are confident that DPZ will meet our conservative 5-year normalized revenue growth rate of 8% and 5-year straight-lined operating cash flows growth rate of 13%. Therefore, there is no change to our 1-year Price Target of $498/share for the company. Reiterate Buy Rating. (Please go through our initiation report “Domino’s Pizza: Set To Capture An Additional Fraction Of The High Growth Global Pizza Market” and additional notes for our long term opinion on the stock).

Key Takeaways From The Fourth Quarter

F4Q2021 Results Summary. For the period, revenues of ~$1.34 billion (-1% on a year over year basis) missed consensus estimates of ~$1.38 billion, and earnings per share of $4.25 (+10.4% compared to F4Q2020) was below analyst projections of $4.29. On a year-over-year basis, global retail sales declined 0.2%, U.S. sales decreased 2.6%, and international sales increased 2.2%. Same-store-sales were higher, with the U.S. growing 1% and international 1.8% over F4Q2020. Net income for the period was ~$156 million, reflecting an expansion of 2.5% over the previous year’s same quarter. During FY2021, the firm generated operating cash flows of ~$654 million, and free cash flows of ~$560 million.

International Business Being Positioned As Growth Leader. Looking ahead, the international business will drive most of DPZ’s growth through massive new unit development. The plan is to add another ~10,000 stores to the F3Q2021 end footprint of 11,909 restaurants, in 15 key countries, including China, which will go to 5,000 from 389, India which will go to 3,000 from 1,445, France/Germany/Brazil which will go to 1,000 each from 454, 377, and 306, and Japan slated to expand to 2,000 from the current 842 stores.

Contrary to our prediction for domestic stores, we expect international retail sales growth to be driven by the increase in the number of stores and same-store growth. In that regard, it is noteworthy that foreign retail sales growth has been strong for a while before the pandemic surfaced, with the FY2021 result at 17.1% on a year-over-year basis, representing the best outcome since FY2016. In addition, during the previous year, on a two-year basis, international retail sales expanded by 23%. In addition, the fourth quarter was DPZ’s 112th consecutive quarter of positive foreign same-store sales. Moreover, profitability remained solid, with cash-on-cash returns averaging ~3 years.

Clearly, DPZ considers the international opportunity as a primary growth driver and is assigning significant resources behind it. We view the foreign market as low hanging fruit and are solidly in agreement with the strategy.

Labor Challenges Remained An Issue. Shortage of front-line staff, primarily delivery drivers, resulted in reduced operating hours and limited service at numerous domestic stores, during F4Q2021. Considering that fully staffed stores generated an additional 6% in sales while stores that were the most challenged with respect to labor witnessed declines in retail sales of ~7%, staffing levels clearly had an impact on fourth quarter financial results.

In order to encourage relevant talent to consider working for DPZ, the company has spent ~$30 million since FY2019 in increased wages to employees and is contemplating advancing wage spending by $8 million over that expected for FY2022. In addition, the firm has implemented operational changes that have eliminated time-consuming tasks such as pre-folding boxes, in favor of activities such running pizzas to delivery cars, which not only improves the quality of jobs for drivers, but also reduces the average time to deliver an order, which results in an increase in deliveries/hour.

Overall, although we expect these measures to have a favorable impact on employee retention and hiring, it appears likely that the driver shortage will persist for awhile, due to macro factors shaping the U.S. employment environment.

Company Implemented Landmark Changes In Pricing. Effective January 31, 2022, the $7.99 large 3-topping pizza carry-out deal is available only for digital orders. In addition, starting on March 14, 2022, the mix-and-match menu which was earlier priced at $5.99 for any two 3-topping medium pizzas or sandwiches, has increased to $6.99 for delivery orders while remaining the same for carry-out transactions. Further, the mix-and-match menu has been expanded to include three additional items, 32-piece parmesan bread bites, 6-piece wings, and three piece chocolate lava cakes.

With regard to the $7.99 carry-out offer turning on-line only, the endeavor is beneficial as digital orders are typically associated with higher check values, provide DPZ an opportunity to enroll additional members to its loyalty program, and generate higher margins as they require less labor than phone orders. In the context of alterations to the mix-and-match pricing, the maneuver will deflect some of the inflationary pressures related to commodities and labor, and provide franchisees an opportunity to derive growth from increases in both ticket and traffic.

We are encouraged by these changes as they will improve DPZ’s revenues, margins, and earnings without damaging the “good value for money” image the firm enjoys among customers.

Carry-Out Sales Gathered Momentum. Carry-out orders rebounded strongly from the significant slump they had experienced through a majority of the pandemic. During F4Q2021, carry-out sales expanded by ~10% on a year-over-year basis, and by ~16% on a two year basis. The fourth quarter outperformance was driven by increase in orders as well as ticket. Considering the growth in carry-out sales evidenced during the fourth quarter, it appears likely that labor shortage did not have an impact on the service.

Car-side delivery where DPZ servers run orders (that have been placed and paid for digitally) to customer cars within two minutes of their arrival to the restaurant, accounted for a significant fraction of growth in carry-out orders over the fourth quarter. Given that awareness surrounding the firm’s car-side delivery is still growing, we anticipate significant expansion in carry-out sales based on the service.

Further, as DPZ’s carry-out sales on average account for ~1/3rd of its total sales and represent ~16% of the total carry-out market, there appears room for considerable growth in the category.

Balance Sheet Remains Strong. At the end of F4Q2021, the company had an unrestricted cash and cash equivalents balance of ~$148 million and long term debt of $5.07 billion on its balance sheet. In regard to available funding, DPZ has $156 million from a variable note it issued previously, and additional capital from a recent refinancing. Given these factors, we believe that the firm will handily maintain liquidity over the final stretch of the pandemic. DPZ announced a dividend of $1.10/share for the fourth quarter, and had ~$704 million remaining on a $1 billion share repurchase program.

Bottom Line

Considering the runaway growth DPZ’s U.S. business experienced over the pandemic, squeezing out additional strong growth from the domestic market, will be a challenge. Combining that element with difficult macro conditions, the company is in for tepid U.S. growth for the foreseeable future. Although, some of the slack in earnings related to state-side operations will be off-set by the strength of the international business, growth rates witnessed during the pandemic are unlikely to reoccur.

We view DPZ as a mature company with its rapid growth days behind it. That being said, we don’t see much on the horizon that will knock the firm off its front runner position in the global pizza market. Given that DPZ generated ~$18 billion in retail sales last year, the reasonable growth in revenues and earnings we are predicting will handily fund the large dividends the company routinely provides investors.

Overall, DPZ’s stock is a must Buy for folks seeking a safe investment which provides significant quarterly dividends.