Domino’s Pizza (DPZ) has seen competitive headwinds forming lately, as third-party delivery apps gain traction. Shares are flat year-to-date as investors closely track the competitive landscape, thinking about how it will impact the company’s top line going forward.
In response to the rise of third-party delivery apps, management has been moving forward with their fortressing strategy – a plan focused on significant store openings, created in an effort to provide reduced delivery times to customers. Many investors have shown concern about the strategy pressuring store comps, while others remain optimistic that fortressing will provide Domino’s with a competitive advantage.
Going forward, we believe that third-party delivery providers are here to stay, poised to take over a larger piece of the delivery pie. This could continue to weigh down on comps growth, although with the vast majority of customers ordering pizza as opposed to delivery, we see the long-term fundamental story for Domino’s remaining intact.
What 3rd Party Delivery Apps Mean for Domino’s
It’s clear the internet has changed the way people buy food. McKinsey & Company expects online food delivery to grow at a CAGR of ~15% through 2020. What isn’t clear is who the beneficiary of this growth will be. Looking ahead over the next several years, we believe that both restaurants and delivery apps will share in the gains, although for some businesses – such as those in the pizza space – benefits might be limited.
Pizza has long been the main food option when delivery was the consumer’s priority. Even today, food delivery dollars are heavily allocated to pizza. In areas with little to no coverage from the third-party delivery apps, pizza remains one of a few delivery-food options for consumers.
Thanks to the rise of third-party delivery apps, however, this is no longer the case. This is magnified by strong promotional activity from companies like Postmates (POSTM), UberEats (UBER), and DoorDash (DOORD). Through delivery apps, consumers now have a much wider food offering at a very compelling price point. With many more options than have historically been available, consumers are choosing to order food in other categories. This has led to a shift in demand away from pizza, and into other food groups – an interesting situation arises where other food categories see higher volume from delivery apps, while pizza actually sees watered-down growth.
In spite of this, we don’t believe that the impact to Domino’s will be all that significant. According to a survey conducted by Stifel, the majority of customers order pizza delivery simply because that is the food option they desired. With this in mind, we believe risks to the company’s core business is minimal – especially when taking into account the heavy promotional activity being pushed out by the delivery apps.
When it comes to being on the offense, management’s focus should be on growing their share in the pizza space. With retail growth higher than total market growth, the company has been achieving this. Domino’s has long been focused on providing a best-in-class customer experience. Through offerings including fast delivery and competitive pricing, Domino’s has been able to differentiate themselves from their competition. They have done an impressive job, posting 33 consecutive quarters of positive comps growth in the U.S. (102 consecutive quarters internationally).
With nearly a quarter of digital delivery order market share, the company has positioned themselves well to service rising consumer expectations. Going forward, we expect to see Domino’s concede share of digital delivery to 3rd party apps as delivery revenues in other food categories outpace pizza. But as the digital delivery pie grows in size, we don’t expect this to have a negative impact on Domino’s. By offering quick delivery at a compelling price point, they’re positioned to be competitive.
When looking at the reasons consumers pass on ordering food, price comes in at the top of the list. Here is where the supposed opportunity lies in management’s fortressing strategy, though. By integrating the delivery process into the business, Domino’s stands to realize savings compared to other restaurants which are outsourcing delivery. On top of this, with their delivery times being as low as 16 minutes in some areas, they can offer a superior service (vs. delivery apps).
Connecting the dots shows an interesting picture where Domino’s is competing in two areas – pizza and delivery. Delivery growth has been driven by new third-party apps, and although Domino’s might concede share in the short run, we expect they’ll be able to offer an attractive value proposition keeping them competitive as the digital delivery pie grows. On the other hand, market share gains in pizza is key. With heavy investments in the delivery process compared to competitors, we believe Domino’s will continue to perform in the coming years.
Comments On Valuation
Domino’s shares are currently trading at ~27x earnings, in-line with peers. The company pays out a dividend yielding ~1%, which is almost half the peer median yield of 1.8%. Alongside dividends, the company has repurchased shares in the past. Going forward, we believe management has found a healthy balance between rewarding shareholders and reinvesting in the business.
Excluding net debt, Domino’s Pizza trades at nearly ~23x EV/EBIT, again in-line with peers. As we mentioned, the company is fairly leveraged, posting a shareholder deficit on their balance sheet. When it comes to servicing debt though, the company doesn’t face any notable issues.
With other restaurants experiencing stronger benefits from delivery, a case could be made for a premium relative to pizza chains. Yet because this delivery growth does come at a higher cost (e.g., increased packaging, commissions), we don’t see a valuation premium being justified. Domino’s on the other hand has constructed some protection through fortressing, which dampens cost effects – but because they’re forced to compete with delivery app price points, the economics might not be as lucrative in the short run (they have offered 50% delivery discounts in the recent past).
Today’s valuation in-line with peers is more than reasonable in our eyes. We expect peer group valuations to remain this way going forward. For shareholders invested for the long haul, Domino’s pizza remains a healthy selection well positioned to compete with both pizza peers and delivery apps.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.