An unlikely contender for Yum! Brands’ (YUM: Charts, News, Offers) international dominance of the fast food industry has emerged – Domino’s Pizza (DPZ: Charts, News, Offers), long-time rival to Yum’s flagship Pizza Hut restaurants. The company reported small, but significantly positive profits for the fourth quarter due to strong international sales. The company currently operates across the United States and 60 international markets. In an industry dominated by burgers, can Domino’s Pizza satisfy the international community’s desire for an alternative pizza choice to Pizza Hut?
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Ann Arbor, Michigan-based Domino’s Pizza, currently owns 8,999 company- owned and franchise stores – its domestic operations consist of 4,461 franchise stores and 466 company-owned stores, and its international operations consist of 4,072 franchise stores. It also operates a domestic supply chain segment, which manufactures its food supplies and equipment for its stores. Although Pizza Hut is the world’s largest pizza chain, Domino’s holds the title of the world’s largest pizza delivery chain, with the most pizzas delivered to homes worldwide. The company popularized the “30 minute or free” guarantee, which it later retracted due to reckless driving by its deliverymen. As of 2007, the company has used the slogan “You Got 30 Minutes,” which alludes to the earlier pledge without the free or discount pizza guarantee.
For the fourth quarter, the company reported a 2.3% rise due to reinvigorated domestic sales, which it accredits to a revamped recipe and a new lunchtime menu, as well as strong international sales aided by a weak dollar. Its same-store sales increased by 6.3% in America and its same-store sales abroad increased 9%. Last quarter, Pizza Hut’s international same-store sales increased 10%, while laggard Papa John’s International (PZZA: Charts, News, Offers) increased 0.7%. Domino’s earned 39 cents per share, or $24.2 million, up from 41 cents per share, or $23.6 million, the previous year. Debt extinguishment costs deducted a cent from this quarter’s earnings, whereas it added 11 cents to the previous year’s earnings. Revenue gained 3.7% to $480 million, and operating margin increased to 28.4% from 27.9% despite rising commodity costs. Analysts had forecast an EPS of 40 cents on $484 in revenue.
Looking forward, rising food costs, especially the price of wheat and cheese, will significantly impact the company’s margins. Cheese is particularly worrisome, as the price of block cheese has consistently risen to the current $1.99 per pound. In addition, corn, beef and poultry costs will also affect profits. The recent spike in crude oil prices due to Libyan turmoil will also affect Domino’s earnings in three main ways. Firstly, Domino’s drivers cover 10 million miles weekly in deliveries. Secondly, its domestic supply chain, which delivers food and supplies by truck, consumes large amounts of diesel fuel. Lastly, rising fuel costs will increase the costs of raw materials, which will affect the domestic supply chain’s ability to produce inexpensive ingredients for its domestic and international segments. Due to the competitive nature of the pizza industry, Domino’s will unlikely raise prices on its products, and absorb the cost instead, impacting its margins.
Although margins are expected to be pressured, international markets may be the company’s salvation. Domino’s will likely follow Yum’s example and expand aggressively into China and emerging markets. Both Yum and Domino’s have been quick to cater to local markets, offering a wide array of seafood pizzas and pasta dishes in China. Through KFC, Yum was able to penetrate so deeply into the Chinese market that it has set up a secondary base of operations there, an example which Domino’s could follow.
Shares of Domino’s Pizza currently trade 10.46 times forward earnings with a PEG ratio of 1.19. Several analysts moderately lowered price targets on DPZ, but overall sentiment is still bullish with an average price target of $20.
Other News About DPZ
Domino’s Pizza Topples on Food Costs
High food costs impact Domino’s margins.
Can Domino’s Swallow Higher Costs?
How can Domino’s increase its revenue?
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
