Domino’s Pizza ( (DPZ) - Get Domino's Pizza, Inc. Report) is colder than yesterday’s pepperoni this morning following weaker than expected earnings -- and investors should be looking for a place to buy shares.
The Ann Arbor, Mich.-based company reported third quarter financial results Thursday before the open. The company earned $2.49, per share versus the $2.79 per share analysts expected. Investors are missing the bigger story.
Domino’s is winning the digital transformation megatrend.
Retailers are in a bind. Their customers want products and services on demand. They demand payment and delivery options. They expect their favorite stores to give them the conveniences that have come to expect online. It’s a tough ask for a sector deeply resistant to change.
Domino’s Pizza has been through countless iterations in its relatively short lifespan.
Founded in 1960 as DomiNick’s by two Irish American brothers, the idea was always to build a chain of stores dedicated to tasty pizzas, fast service and reasonable prices. Five years in, Tom Monaghan had bought out his brother, purchased an addition two locations and changed the name to Dominos. That’s when the pieces began to fall into place. Franchising and aggressive expansion pushed the number of storefronts to 200 by 1978.
When giant food processors Kraft Heinz ( (KHC) - Get Kraft Heinz Company (KHC) Report) and Unilever ( (UL) - Get Unilever PLC Sponsored ADR Report) entered the market in the early 2000s, the fresh pizza delivery business was thrown into a tailspin. New rising crusts recipes and clever marketing posed an existential threat to national pizza chains.
Domino’s managers went back to the basics, and they embraced technology.
The company released a pizza tracker in 2008. It was silly idea but customers were able to follow the progress of their orders online. Pizza Tracker gamified the process, and won legions of new fans captivated by their iPhones. A year later the company spent millions re-imagining all of its pizza recipes.
Patrick Doyle, chief executive in 2010, doubled down on technology. His teams implemented a digital first strategy. Orders placed on smartphones and smart TVs got a zero-click purchase experience. Overall sales zoomed from $1.6 billion in 2011, to $3.4 billion in 2017.
The genius was those digital orders were way more profitable. With the entire virtual menu laid out in front of them, customers often ordered high margin cheesy breads, salads and soda to make a meal of it, increasing the average order size.
By the first quarter of 2019, 65% of all Domino’s sales came from digital channels, including new platforms like Google Home, Facebook Messenger, Apple Watch and Twitter ( (TWTR) - Get Twitter, Inc. Report). Credentialed customers could even order Domino’s by texting a pizza emoji on their smartphone. With advanced mapping, you can get pizza at a park or the beach without an address. The business was positioned perfectly for digital evolution, with a unique competitive advantage.
Fast delivery is a cornerstone of the Domino’s experience. To get there, the company built a vast network of stores, all connected by the same technology infrastructure. Regardless of location, customers’ preferences and their orders are quickly processed and routed to the nearest storefront.
When Uber Eats, a division of Uber Technologies ( (UBER) - Get Uber Technologies, Inc. Report), GrubHub ( (GRUB) - Get Grubhub, Inc. Report), privately held Door Dash and other companies expanded door-to-door delivery during the height of COVID-19 pandemic, Domino’s managers doubled down on their storefront strategy.
Rich Allison, the new chief executive officer, pledged to open 10,000 new stores to ensure faster delivery times. In theory, saturation reduces overall unit costs and improves wages for workers. It also encourage customers to pick up orders on the way home from because stores are nearer.
Carryout, according to an Oct. 2019 corporate press release, represents a new business model with 2.5x the market opportunity of delivery. The strategy also offers the unique benefit of better margins, because no delivery costs are incurred, freeing up cash flow for a wide variety of new $7.99 carryout menu items.
The company noted today that stores can’t keep up with demand for new pickup menu items. And increased deliveries, due to the lingering impact of the pandemic, have increased average order sizes.
While the top end of the business saw revenues surge to $968 million, up 17.9% year-over-year, unfortunately earnings have been impacted by higher wages and food costs.
Shares of the pizza giant slumped 8.5% to $394 this morning before stabilizing just above the $400 level. Even with the weakness, the stock is still ahead 46% in 2020.
Domino’s is an unconventional company. Managers set the standard by disintermediating the quick service restaurant experience with technology. The company is clearly winning. Regardless of the smart device or location, a tap or swipe means a piping hot pizza is only moments away.
Shares trade at 33x forward earnings and 4.4x sales. The stock may drift into the high $300s where longer-term investors should consider new positions.