2023-07-13 08:30:00 ET
Summary
- Domino's Pizza has partnered with Uber to allow US customers to order through Uber Eats and Postmates apps, with Domino's employees making the deliveries.
- The deal is expected to facilitate global ordering in markets where both companies operate, covering about 70% of Domino's global stores, with the majority of revenue expected to come from the domestic market.
- Despite the market's positive reaction, I remain skeptical about the value this partnership will bring to Domino's, citing potential cannibalization and other issues.
Investors in pizza giant Domino's Pizza ( DPZ ) experienced a really great day on July 12th. Shares of the company closed up 11.1% after news broke that the company struck an interesting deal with Uber Technologies ( UBER ). It is indisputable that this will prove to be a beneficial deal for Uber, but the extent to which this maneuver will benefit Domino's Pizza is less clear. Obviously, the market is optimistic about the development. But when I dig into the numbers, I don't see any real reason why shares reacted as bullishly as they did.
An interesting announcement from Domino's Pizza
On July 12th, the management team at Domino's Pizza announced that the company had struck a deal with Uber whereby US based customers will be able to order the company's products through both the Uber Eats and Postmates apps. Instead of having the freelance drivers that traditionally work for these apps deliver the products in question, employees of Domino's Pizza and its franchisees will make said deliveries. We won't see this occur all at once though. This Fall, the two companies will launch pilots in four different markets in the US. But by the end of the year, the expectation is to provide this delivery service across the nation.
It's important to note that this relationship is being set up to facilitate global ordering in the markets in which both companies operate. Combined, the companies touched 27 international markets. At the end of the day, this exposure will allow Domino's Pizza to have its products delivered directly to consumers in areas in which about 70% of the firm's stores are located globally. This may sound like a very significant move. But by the admission of Domino's Pizza itself, international delivery is truly underdeveloped at this time. For at least the first couple of years, the vast majority of revenue associated with this relationship will likely come from the domestic market.
Conceptually, this has the potential to be significant in size. In 2022, The US-based delivery segment for the pizza industry totaled $17.3 billion. That's an impressive 43% of all U.S. consumer spending at pizza QSRs (Quick Service Restaurants). Management claims that the company has the largest chunk of this market, totaling 32% of all sales. The firm also has a 19% stake on the $18.9 billion carryout market.
To be perfectly honest, I am skeptical about how much value this relationship will bring to Domino's Pizza. According to the price movement that occurred in response to the announcement, the market placed a value on this relationship of $1.39 billion. That's the amount by which the market capitalization of Domino's Pizza increased on July 12th. Part of my skepticism centers around the fact that , on a global scale in the markets in which it operates, food delivery services provided by Uber account for only about 3% of the gross billings generated by the restaurant industry.
I have other concerns about this picture as well. One of the problems centers around potential cannibalization. Already as I stated, Domino's Pizza has a large chunk of both the delivery and carryout markets. Will the company actually achieve meaningful incremental sales growth or will customers that would have otherwise ordered some other way just order a different way? This is something that only time will tell. But investors should expect at least some degree of cannibalization.
Even if we see attractive growth, everything is relative at the end of the day. As I said already, the vast majority of any additional revenue the company should experience will involve its US based restaurants. At the end of the most recent quarter , the firm had 285 company owned restaurants here at home. It also boasted 6,423 franchised locations. The remaining 6,708 locations that the company has are international. During the 2022 fiscal year, only $445.8 million worth of revenue for the company out of the $4.54 billion of overall sales, came from its company owned restaurants. Even if the company were to experience a 20% bump in revenue, that would total only $89.2 million coming from company owned locations. When it comes to the franchised locations here at home, the firm generated only slightly more revenue, about $556.3 million in total. But because of the company generates royalty fees of about 5.5% as opposed to revenue outright, a 20% sales increase for franchised locations would boost revenue for the parent company by only $6.1 million annually.
The biggest source of revenue for Domino's Pizza in 2022 came from its supply chain operations. This includes the delivery of not only frozen and other items to various customers for the purpose of resale, but also the delivery of ingredients to its company owned and franchised locations. This could naturally be an area where the company benefits. But we don't have any strong evidence that sales growth would be materially aided by this development anyways. So any guess that we would have would be speculative at best.
Unfortunately, after shares of the company spiked in response to this development, I must also make the case that shares are no longer attractively priced. They look to me to be fairly valued. Using data from the 2022 fiscal year, I calculated that the company is trading at a price to earnings multiple of 30.4. The price to adjusted operating cash flow multiple is 25, while the EV to EBITDA multiple came in at 22.4. As you can see in the table below, I compared the company to five similar firms. Using both the price to earnings approach and the price to operating cash flow approach, I found that two of the five companies ended up being cheaper than Domino's Pizza. And when it comes to the EV to EBITDA approach, four of the five ended up being cheaper than our target.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
Domino's Pizza | 30.4 | 25.0 | 22.4 |
Wingstop ( WING ) | 97.8 | 64.0 | 55.2 |
Arcos Dorados Holdings ( ARCO ) | 14.3 | 4.3 | 7.8 |
Restaurant Brands International ( QSR ) | 23.2 | 25.6 | 18.0 |
Yum Brands ( YUM ) | 31.8 | 25.5 | 21.2 |
Papa John's International ( PZZA ) | 34.4 | 20.4 | 17.6 |
As you can see in the chart below, the company does have a history of continued growth, covering not only the past three completed fiscal years, but also covering the first quarter of 2023 compared to the same time last year. Bottom line results have been admittedly more mixed in nature. But that picture does look to be improving so far in 2023. I don't have any strong reason to believe, then, that on a forward basis the firm will be materially cheaper than it is right now. If anything, it will probably be marginally less expensive.
Takeaway
While I appreciate the optimism that market participants expressed in relation to this partnership between Domino's Pizza and Uber, I frankly believe that the response by the stock market was overblown. I would argue that Uber will benefit since it should generate more revenue as a result of additional orders. But when you look at the totality of the picture for Domino's Pizza, I believe that the company does not warrant anything more attractive than a ‘hold’ rating at this time.
For further details see:
Domino's Pizza's Deal With Uber Technologies: A Classic Market Overreaction