DPZ - Domino's Pizza: Growth Acceleration In 2024 Can Drive Stock Higher

2024-01-02 06:09:35 ET

Summary

• Domino's Pizza is well-positioned for growth, with revenue expected to benefit from promotional offerings, a growing loyalty customer base, and improving sales in both delivery and carryout.
• The company's revenue growth in 2024 is expected to improve thanks to value offerings, increasing customer engagement, and new unit development.
• Margins are expected to improve in the medium to long term, driven by sales leverage, productivity gains, and normalization of investments beyond 2024. The company is currently trading below historical averages, making it an attractive investment.

Investment Thesis

Domino’s Pizza ( DPZ ) is well-positioned to deliver good growth acceleration in 2024. The company’s revenue growth should benefit from an increase in promotional offerings, a growing loyalty customer base on its online application, improving sales in the delivery business, and good sales momentum in the carryout business. Furthermore, the re-acceleration of restaurant unit development after a modest 2023 net opening should also boost sales growth in the coming years.

On the margin front, while the FY2024 margin is expected to remain flattish due to elevated investments in long-term growth and productivity initiatives, the margins should improve in subsequent years as the benefits from these investments start showing up. DPZ stock is also trading below its historical averages, which combined with good revenue and margin prospects makes the company a buy at the current levels.

Revenue Analysis and Outlook

After seeing good growth in FY20 and FY21, Domino’s Pizza’s same-store sales growth was negatively impacted in recent years by staffing shortages due to a tight labor market which impacted its delivery operations, a lower order count in an inflationary environment, especially in the delivery business which has additional delivery fees and tips, and a shift in consumer preference towards dine-in options post-reopening.

In the third quarter of 2023, lower order count in the U.S. stores continued to impact sales. These were partially offset by price increases, good strength in the carryout business, and new unit development. Overall, on a same-store basis, revenue decreased by 0.6% YoY for total U.S. stores (both company-owned and franchised) due to lower order count, partially offset by a 3.2 percentage point benefit from price increases. International same-store growth increased by 3.3% YoY due to pricing and increased promotional offerings, more than offsetting lower order count. In addition to lower same-store sales growth in the U.S. stores, the re-franchising of 114 U.S. company-owned stores in Q4 2022 also impacted total company sales. Moreover, the lower demand in the supply chain segment due to lower order volumes at the U.S. franchised stores also impacted total company sales. As a result, total company revenue declined by 3.8% YoY to $1.02 billion.

Looking forward, I believe the company should be able to improve its revenue growth in 2024 thanks to value offerings, increasing loyalty customer base, good momentum in the carryout business, improving delivery business, and new unit development.

Domino’s has been known for its value offerings across the globe as the company has always been consistent with its promotional offers. With the U.S. as well as global economies seeing persistent inflation over the past couple of years, these value offerings have become a focal point of the company's revenue growth strategy. They play a pivotal role in drawing consumers to the brand. Over the past few quarters, the company has accelerated its value offers and promotions to improve order count and frequency.

For example, earlier Dominoes had an offer that after ordering from Dominoes for 6 times, you will get a free pizza on your 7th order. Considering that during inflation order frequency reduces among customers, the company has divided those 6 order occasions into three different redemption point levels. The company calls this its 20-, 40-, and 60-tier offer. For this, a customer gets 10 points for every minimum order of $5 on its application. At the 60-point level, one can get free items like pizza, big sandwiches, pasta, and lava cakes. At 40 points, Bread Twist and Stuffed Cheesy Breads are available as free options, and at 20 points, the company is offering free single-serve beverages, Parmesan Bread Bites, and Dipping Cups. This is helping increase order frequency and customer engagement.

Moreover, the company also rolled out an emergency pizza promotion in the U.S. in October, which is like a buy-one-get-one-free pizza offer. Under this promotion, customers can receive a complimentary pizza within a 30-day window after ordering one pizza from Domino’s. I believe this offer should gain good traction from customers leading to an uptick in order frequency in the coming quarters.

These deals are also helping increase active members in its loyalty program on its online application. In the first three quarters of last year, the company successfully added 2 million active members, reflecting a ~7% increase from the 2022 year-end. This increase can be attributed to heightened engagement in redeeming free items offered through these promotions. The company plans to keep introducing new offers moving forward. This should keep the engagement rate elevated and help increase the order count.

The company is also focused on bringing personalization to its online application. According to management, the loyalty program over the years has provided a huge set of data on customer preferences and activities. So, in 2024, with the help of machine learning models, the company aims to achieve personalization for its online application. This means customers can get personalized food options and promotional offers that are right for them individually. In line with this, the company has partnered with Microsoft ( MSFT ) to leverage its generative AI technologies. These initiatives should also boost active membership for its loyalty program.

I expect these value offerings and increasing customer engagement should also help in improving both carryout and delivery sales.

In addition, the company's delivery sales should benefit from improved driver availability. Over the past couple of years, the company’s delivery business has been negatively impacted due to driver unavailability in a tight labor market. However, according to management, driver availability has reached pre-pandemic levels, and that has helped moderate the delivery sales declines over the last couple of quarters.

Moving forward, the company is also introducing aggregators partnerships for its U.S. delivery services. Internationally, aggregators have helped the company in increasing its customer base and also gain market share. The company is replicating a similar strategy to support the recovery and long-term growth of the delivery business in the U.S. and has partnered with Uber Eats ( UBER ). Management expects Uber Eats to add new customers to its platform and help increase pizza delivery market share. So, the delivery business should start showing positive growth in the coming year.

Further, I expect the carryout business to continue seeing good growth. The carryout business has seen strong growth momentum over the past couple of years and is up more than 20% over the last 2 years. The biggest driver was week-long national carryout deals such as get any 2 items (or more) at $6.99 each, or any 3-topping large pizza at $7.99. Additionally, carryout services cost customers comparatively less than delivery (which have delivery fees and driver tips), adding another layer of value to the customer. Moving forward, the company plans to sustain the growth momentum of the carryout business through further launching carryout deals in the U.S. A recovery in delivery sales combined with sustained momentum in carryout sales indicates an acceleration in the sales growth in the coming quarters.

In the Q3 2023 earning call , CFO Sandeep Reddy commented,

...we expect delivery orders to have an improvement in trend in Q4 as our updated loyalty program and our emergency pizza promotion have now rolled out, and that followed by a considerable improvement in 2024 as a result of transaction growth from our UberEATS partnership and the other initiatives previously shared with you. Including consistent trends versus Q3 in our carryout business, we expect U.S. sales comps to be positive in the fourth quarter.”

Further on the December 2023 Investor Day, CFO Sandeep Reddy commented,

when we talked back in October on the third quarter call, we were really excited about the launch of the loyalty program, and things were going very well. And we had seen some good transaction traction already from the launch of the program. What I'm happy to tell you is we're actually tracking slightly better than what we actually saw at that time back in October. And we're already very bullish. So we're pretty excited about positive comps coming in the United States. And so we're happy to actually say that the traction on the delivery business as well as our carryout business has been very good and driven by transaction growth. And it was really driven by the loyalty program that we talked about, and the launch of Emergency Pizza, which is a great customer acquisition tool into the loyalty program as well, which has worked for us.”

This commentary by management indicates improving growth trends in Q4 2023 and beyond.

Moreover, to further position for long-term growth, the company is also focused on expanding its store counts both domestically and internationally. According to management, a new store opening in an existing service area can bring up to 80% incremental carryout customers to Domino’s as carrying out convenience increases. The additional stores within any service area help customers get their pizza from the nearest one, rather than driving a bit far to only one servicing store like before. This should also help reduce delivery time as the customers would get pizza delivered from the store closer to their location, improving the delivery experience.

While 2023 was a relatively slow year in terms of net new store openings, the company plans to re-accelerate its store unit openings in 2024 and beyond. In 2023, the company saw net unit development growth de-accelerate as the company closed its underperforming stores both nationally and internationally. In addition, exit from the Russian market in the wake of the ongoing Russia-Ukraine war also impacted the net growth rate. However, according to the company these closures are near completion, and should not impact the net unit growth rate moving forward. Hence we should see re-acceleration in net unit development rate in the coming year. Moreover, the company laid out its longer-term store growth targets in the recent Investor Day held in December. In the U.S. market, DPZ aims to reach 7,700+ store counts in the U.S. by 2028, up from the current ~6,800 stores, implying 175+ stores annually over the next 5 years, with a further long-term potential of more than 8,500 U.S. stores. In the International markets, the company plans to reach 18,500+ stores by 2028, up from the current ~13,400 stores, which implies ~900+ stores on an annual basis, with further long-term potential of 40,000+ stores internationally.

I believe this unit growth re-acceleration along with recovery in same-restaurant sales helped by value offerings, an increase in loyalty base, strength in the carryout business, and improving delivery sales should help the company post good sales growth in 2024 and beyond. Management has shared its targets of 7% CAGR for global retail sales (ex. FX) between 2024 and 2028 and I am optimistic that the company can achieve this target.

Margin Analysis and Outlook

In 2022, the company experienced labor inefficiencies due to the unavailability of delivery partners and high raw material costs, which impacted margins. However, over the past few quarters, Domino’s margins recovered with the help of price increases, moderating inflation, and productivity benefits.

In the third quarter of 2023, the company continued its margin growth momentum as overall food cost inflation continued to moderate. In addition, good growth in franchise fees from both domestic and international markets and procurement productivity benefits within the company’s supply chain segment also helped the company increase its margins. These were partially offset by increased promotional offerings and, higher labor wages. Overall, the gross margin increased by 310 bps YoY to 38.8% and the operating margin increased by 190 bps to 18.4%.

Looking forward, management has shared an 8% + annual operating income growth target on a 7% + annual sales growth (ex. FX) for FY24 to FY28 indicating the margin improvement to continue in the coming years.

In terms of cadence, the company’s FY2024 margins are expected to be flattish due to elevated promotional offerings, higher investments in digital platforms, and acceleration of unit developments.

The elevated investments in promotional offerings, enhancement of digital platforms, store efficiency measures, and new unit development are important to increase long-term sales volume. However, once the benefits of the investment start showing in terms of volume leverage and increased store productivity and efficiency, the company’s margins should start seeing improvement from FY2025 onwards.

One good example of the company’s investment in improving productivity is Dom OS, which is a collection of smart tools that improve overall operations. These smart tools are expected to optimize everything from order flow to store operations, ensuring efficiency, reducing food wastage, and enhancing operational consistency, driving productivity benefits. Additionally, Dom OS extends beyond operations. It also incorporates a new labor tool to optimize scheduling and increase team member flexibility and engagement. This should also help in improving overall productivity for both the franchises and company-owned restaurants. As the investment in these kinds of tools normalizes beyond FY24 and their benefits start showing, it should support margin growth. Hence, I am optimistic about the medium to long-term margin growth prospects of the company.

Valuation and Conclusion

Domino’s Pizza is currently trading at a forward P/E of 26.2x FY24 consensus EPS estimate of $15.73. This is below its 5-year historical forward P/E average of 29.88x. In addition, DPZ is also trading below its peer Papa John’s ( PZZA ), which is trading at 27.45x FY24 consensus EPS estimate of $2.78.

I believe the company’s growth should see re-acceleration over the coming quarters thanks to increasing promotional offerings, increasing loyalty customer base, improving delivery sales, good momentum in the carryout business, and new unit development both domestically and internationally. Margins should also resume its expansion beyond FY24 with the help of sales leverage, normalization of investments, and productivity benefits.

The prospects of growth re-acceleration in 2024 coupled with a lower than historical valuation make the company a good buy.

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