Introducing Domino's Pizza
06 March, 2015
Manuel Greenland tells us what he likes about Australian portfolio holding Domino's Pizza.
Slice of Life
Domino's Pizza Enterprises (trading as Domino's Pizza) is an Australian listed company that holds the master franchise for Domino's Pizza in Australia, New Zealand, France, Belgium, the Netherlands and Monaco. It also has a 75% interest in Domino's Japan.
Domino's runs the largest pizza chain in Australia and New Zealand. Approximately 70% of Domino's Australian stores are franchisees, while the remaining are owned by the company. Domino's Pizza has more than 1400 stores, employing approximately 26,000 and is the leading international Domino's franchisee.
It is easy to dismiss a company like Domino's as just another fast food company, competing with well resourced global competitors like McDonalds and KFC, both of which have significantly greater scale and reach. And that's not to mention the array of independent pizza outlets that offer more gourmet pizzas, catering to local tastes. But we like Domino's because it has been successful in a competitive industry and has some "moat" characteristics that should enable the company to continue to perform:
- scale - its network and infrastructure would be hard to replicate
- intellectual property - clearly the brand has value and in addition, the company receives supporting marketing know-how in terms of menus, franchise agreements, system knowledge and online marketing and distribution technology
- switching costs - the existing Domino's franchisees are contractually bound to the Domino's group and there would significant costs associated with them leaving the franchise and needing to reinvest in new branding and systems
We believe Domino's is a clear Australian growth stock with store expansion opportunities, productivity opportunities and margin opportunities. The CEO Don Meij is a Domino's legend. He started as a franchisee, built up a number of franchises, consolidated the Australian business and eventually secured the franchise. His execution record is ostensibly the best globally, earning him the franchise territories in Europe and Asia. You would have to credit him with clarity of vision, strong leadership and the wherewithal to lead the pizza industry into the important trends of Health, Home Delivery and use of Big Data while his competitors fumbled.
The business is essentially a master franchise where Domino's earns a franchise fee on all franchisee sales. Domino's then pays a portion of this to Domino's Pizza Inc in the US. Domino's earns further income from the sale of inputs to franchisees, and it charges a range of service fees. For the fee it pays to Domino's Pizza Inc, the company accesses the brand, global IP (which is principally menus and marketing programs), but also importantly the market-leading technology that goes behind the company's web-based business model. It also accesses best practice from around the world and an exchange of ideas with other participants in the global network.
By customising both its pizza and service offering, Domino's has grown from 178 stores in 2001 to over 1400 stores at December 2014. Notwithstanding the significant costs to support this expansion, the business has grown profits by more than 17 times over this period. Domino's has a strong focus on return on capital in managing its business, while at the same time allocating capital for future growth. The significant reinvestment of operating cash flows is consistent with a strong growth story and we are comfortable with our projections for continued growth.