Domino’s Pizza Group (DOM) used to be a stock market darling. Excellent branding, roomy margins, good returns on investment and an abundance of literal and figurative dough underpinned a convincing bull case. However, something has gone wrong with the corporate recipe. Growth has been hampered by fallouts and walk-outs, and investors are nervously awaiting the pizzeria’s half-year results next month.
For a company that makes such cushiony, soporific foodstuff, Domino’s has proved a turbulent place to work. During his six years at the helm, David Wild saw four finance directors come and go, and the group has accrued three more since Wild’s own resignation in 2019. They have been accompanied by three new chief executives.
Away from the boardroom, rows with franchisees have also been rumbling, and investors are getting grouchy, too. In June, almost a quarter of shareholders voted against a policy that would see the latest chief executive paid £6.8mn if he meets certain targets.
The question for investors is whether Domino’s is getting back on a stable footing after years of disruption, or whether the dynamics of the business have permanently changed for the worse.
Back to basics
In order to answer this, it is important to understand how the company makes money. Domino’s Pizza Group owns exclusive franchise rights in the UK and Ireland to operate the Domino’s pizza brand. These rights are granted by the “global master franchisor” – otherwise known as Domino’s Pizza International.
Under the agreement, franchisees manage the vast majority of Domino’s 1,247 stores. Domino’s itself sells supplies to the franchisees and collects royalties from them. The royalty fee is 5.5 per cent of total outlet revenue – referred to as ‘system sales’ – and about half of this is paid up to the parent company.
Franchisees set their own prices, pay their own staff and open new stores. Meanwhile, Domino’s handles national marketing, menu creation and, crucially, the ingredient supply chain. Selling ingredients to franchisees – as opposed to selling pizzas to customers – is the group’s biggest money spinner, and in 2022 Domino’s generated 68 per cent of total sales from its supply chain, compared with just 13 per cent from royalties and rents.
On the face of it, this is an excellent business model: it’s not capital intensive and very cash generative. Moreover, although there are cost pressures – the group is particularly sensitive to cheese and chicken prices – it’s a cost-plus model, meaning the franchisees bear the brunt of supply chain inflation.
This ushers in its own problems, however. Between 2018 and 2021, franchisees argued that Domino’s wasn’t shouldering a fair share of cost increases and that opening new outlets wasn’t mutually beneficial. The three-year row suppressed store growth, and was only resolved in December 2021 when Domino’s promised extra investment and incentives in return for franchisees opening 45 new stores every year for the next three years.
Keeping franchisees on side will be critical. Unlike typical retailers, Domino’s doesn’t benefit much from charging end-customers more. After all, the group only takes a small cut of outlet sales. Instead, growth is fuelled by volumes: more pizzas mean more ingredients, which means more high-quality franchisor profits. And one of the best ways to boost volumes is to open more shops.
However, franchisees don’t necessarily feel the same way.
Opening new stores risks cannibalising existing ones, in a process Domino’s describes as “splitting territories”. This will only get worse as more outlets pop up, and consumers are already well served. According to Panmure Gordon, the UK is more densely packed with Domino’s stores than it is with McDonalds, Starbucks and Pizza Huts.
There are already signs that trouble is brewing. Life-for-like volumes over the last four years have only increased by 2 per cent cumulatively, according to analysis by Liberum. Meanwhile, like-for-like order count over the period is down 6 per cent, with growth instead being driven by price increases and extra delivery charges.
Profits have also been stagnating, and Liberum pointed out that share buybacks were the only reason that Domino’s achieved earnings per share growth between 2018 and 2022. These buybacks are themselves controversial, given the group is borrowing money to fund them. Its leverage ratio now sits at 2.06 times and interest costs more than quintupled between 2018 and 2022.
Secret ingredient
Something changed this month, however: the chief executive. Analysts seem unanimously pleased with the appointment of Andrew Rennie, a Domino’s veteran with a proven track record. Numis described him as a “very high quality appointment” who should remove “a key overhang on the DOM share price”. Meanwhile, analysts at Liberum – who had previously described the state of affairs at the pizzeria as “slow degradation” – were so enthusiastic they upgraded the group from a ‘sell’ to a ‘hold’.
It’s a lot of pressure on one man. However, he is taking over a famous brand which is still gaining a bigger slice of the UK pizza market and sits just below Uber Eats, Deliveroo and Just Eat in terms of online orders. Staying popular with the franchisees is now the priority.
Domino’s half-year results will be published on 1 August.
