Domino’s: Fundamentals Still Intact Despite Softer Store Count Guidance (NYSE:DPZ)

Domino’s Pizza (NYSE: DPZ) shareholders have good reason to feel a little wrong recently. While the macro environment is certainly getting more complicated for quick service restaurants (“QSRs”), business here seems to be holding up well well, with comps looking solid, even if a number of his peers are starting to flag.

Instead, the stock has been on a rollercoaster ride recently, ultimately returning a pedestrian 6% since my first play late last year. That’s good enough to come in slightly above average in a difficult period for the peer group, although a single-digit return is still objectively at best. Additionally, these shares reached $533 just a few months ago, and have since fallen to the $415 mark following Q2 results.

The good news is that the core business doesn’t seem to have triggered sales here. Rather, the market became jittery about the company’s future outlook after management suspended near-term unit growth guidance. While that’s a fair concern given the potential implications for global retail sales growth, I’d be inclined to overlook it given that the company’s fundamentals remain solid. As for the stock, it still trades for around 25x EPS, broadly in line with the past, giving investors a credible path to long-term returns of ~9-10%. As such, I leave my original Buy rating unchanged.

The foundations still intact

Business was weak when we first covered Domino’s last December, but between a renewed loyalty offer and a partnership with Uber Eats, it had some near-term growth drivers to look forward to. Those seem to have done the trick, with comps improving nicely so far this year, bucking the trend seen at many of the company’s QSR peers and going against the general weak consumer narrative.

With that, domestic same-store sales growth (“SSSG”) landed at +4.8% last quarter, with franchise stores outperforming company-operated outlets. This brought US half-year SSSG to a very solid +5.2%. International companies were weaker, although at +2.1% (Q2) and +1.5% (H1) they remain in positive territory.

Unit economics is a key strength for Domino’s. Store-level margins at company-operated outlets haven’t moved much recently, coming in at 17.5% in the first two quarters of the year, but the key point is that franchisees are still making good returns on start-up costs . It’s worth going over the math again because this is what drives long-term unit growth and, in turn, a significant portion of corporate earnings growth.

With that, management said on its most recent quarterly call that franchisees are set for about $170,000 in unit-level EBITDA this year:

Our second quarter financial results were in line with our expectations. Our strong start to the year resulted in an increase in dollar profit versus 2023 for our US franchisees. We remain on track to achieve our goal of $170,000 or more average US franchise store profit by 2024.

Sandeep Reddy, CFO Domino’s Pizza Inc.

Startup costs obviously vary depending on exactly where and what type of store is opened, but the average figure in the US is somewhere around the $450,000 mark. Against $170,000 in annual store-level EBITDA, quick math indicates cash-on-cash returns of ~37%. That is, in the United States. International returns are likely lower because store-level revenues aren’t as high as in the US, though by any reasonable estimate they’re still comfortably in the double digits. These are attractive numbers that will encourage franchisees to expand.

A quicker way to check the health of the franchisee is simply to see if the franchised property is growing. If it is, they are probably making sound. Domino’s had 6,474 franchised stores in the U.S. when we last covered it, plus another 13,435 overseas. Those numbers had grown to 6,617 and 14,024, respectively, as of Q2 2024. So yes, franchise ownership is still growing.

Compared to the year-ago period, the company’s total number of global stores increased by 725, or ~3.5%, to 20,930 last quarter. Note that this is against a macro backdrop of relatively high interest rates (making it more expensive to finance a new restaurant) and declining consumer health in many markets (putting pressure on line-ups and unit-level economics), so this growth is undoubtedly better than it seems. on paper.

With positive headcount and unit count growth, Domino’s continues to report solid growth at the corporate level as well. Revenue was $1.1 billion last quarter, up just over 7% year-over-year, while EPS of $4.03 was up from $3.08 in the same period. Global retail sales (ie, the sum of sales at the restaurant level) were up more than 7% year-over-year.

Unit count guidance is not a major concern

While the company’s global store equity is still growing, management obviously had some disappointment last quarter, which contributed to the stock’s recent weakness. Specifically, the guidance on the number of net units has been suspended, having previously been set at 1,100 per year in the period 2024-2028.

Management attributed this to issues at Domino’s Pizza Enterprises (OTCPK:DMZPY)(OTCPK:DPZUF)(“DPE”), which is closing net stores in several of its territories (Japan and France) that have expanded a little too aggressive. DPE is the company’s largest international franchisee, representing approximately 3,800, or ~18%, of Domino’s Pizza Inc.’s total number of stores worldwide.

It is worth putting this development in some context. First, DPE expanded very aggressively in Japan, opening about 400 stores there during the COVID boom years. DPE currently operates ~1,000 stores in the country, so we’re talking about 40% of real estate opening within a few years during a great time for the pizza business. He probably got a little too aggressive. In total, DPE has about 1,500 units in France and Japan and is closing net around 75. Call it about 5% of total stores in those markets, or about 0.35% of the global total (20,930 in Q2). That’s not a big number in the grand scheme of things, but with international unit growth previously accounting for about 85% of that 1,100-unit-a-year growth target, it had a negative impact on guidance.

I would also point out that the US stores are much more profitable for Domino’s than the international ones. Several things drive this. First, the royalty rate is typically 5.5 percent of store-level sales for U.S. restaurants, compared to about 3 percent for international ones. In addition, US stores also have higher unit volumes, with annual store-level sales averaging ~$1.35 million versus ~$0.7 million for non-US. Finally, Domino’s has a domestic commissary business that accounts for ~25% of total EBITDA, so it also makes money by selling ingredients and supplies to domestic franchisees.

On a positive note, 2024 guidance of 175 net U.S. store openings remains in place, with that mapping to approximately 2.7% property growth. As I said above, the macro context isn’t great for new restaurant openings right now, so this level of growth looks pretty impressive and is another sign that franchisee health is solid.

ASSESSMENT

Domino’s stock is trading at just under $415 today, up about 6% from its initial close. Earnings have also grown over that period, so the stock is still at a ~25x multiple to current-year estimated EPS.

This remains a good deal for long-term investors. I said last time that I wanted to get a few points a year in the long-term cost/benefit contraction because the business will eventually mature and unit growth will slow. Meanwhile, earnings growth may more than make up for it. Businesses are positive and although close-unit guidance has been suspended, store numbers are still growing, especially in the all-important domestic market. This marks yet another high single-digit annual increase in total global retail sales.

Retail sales are the ones that generate high margin royalty income (as well as commissary sales in the US), so there should be a lot of cost leverage in Domino’s P/L statement. Indeed, management previously had this EBIT growth of $400M by 2028, equal to ~50% of what the company reported last year, while the sell-side consensus currently has EPS growth up over 10% per year through 2026. ~1.5% in dividends, and investors still have a clear path to ~9-10% annualized returns, even after accounting for current P/E.

Summarizing

Domino’s stock has been on a rollercoaster ride since my first play last year. Trading above $530 as recently as June, these shares may have been a bit frothy, with the suspended unit count giving the market an excuse to cut them down to a more attractive level. Most importantly, the fundamentals look intact here, with positive compounds and franchisee health still looking good – especially in the crucial US market.

With this, retail sales growth is still seen driving over 10% annualized EPS growth over the medium term, and the stock’s modest dividend can boost yields up to ~12% on a business-wide basis. At around $415 currently, this gives the stock a path to long-term annualized returns of ~9-10%, after allowing for some slippage from its current 25x P/E. I leave my original Buy rating unchanged.