Domino's Pizza, Inc. (DPZ) Earnings Call Transcript & Summary

Good afternoon, everybody. I'm Brian Bittner, the restaurant analyst at Oppenheimer, and we are thrilled to have Domino's Pizza back at our 2023 Consumer Conference. Domino's doesn't really need an introduction, but it is the largest pizza company in the world with over 20,000 stores in 90-plus markets. And while Domino's has a strong track record of impressive growth, we believe there remains an attractive opportunity for AUV and unit expansion upside moving forward, both internationally and domestically. And at Oppenheimer, we have an outperformed rating with a $375 price target on the stock and we believe shares present an attractive risk reward at current levels, particularly as the company builds a path to improve its delivery business all while continuing to execute against an incremental and very significant carryout opportunity. So with that, as an introduction, I'm really excited to have from the company Sandeep Reddy, the Chief Financial Officer, who joined Domino's in April of 2022 as well as Ryan Goers, Vice President of Finance and Investor Relations. Thank you both for being with us today. We greatly appreciate your time and appreciate your attendance at our conference.

Thank you, Brian. Excited to be here.

I'd like to begin our discussion by just zooming out very high level, Sandeep. You've talked consistently on the last several earnings calls about some of the macro pressures impacting the overall delivery segment. What's your current view on the health of the U.S. consumer through the lens of Domino's Pizza? And how is this shaping your strategy to win market share within QSR pizza?

Thanks, Brian. I think when you actually asked the question on the macro environment, you're right. I mean the macro, especially in 2022, was very challenging from a consumer standpoint. So we saw declines in real disposable income that definitely did impact the delivery segment. But I think as we move into '23, we've seen that kind of inflict and real disposable incomes are beginning to grow again, especially with the inflation coming down. Job growth and wage growth basically continues to hold up pretty well. So typically, you'll see demand being a lagging indicator, but I think the macro is what it is, and it looks like it's actually better than it was looking last year. So that being said, how does that inform Domino's strategy? It doesn't. I mean it's -- the macro is going to be whatever the macro is going to be. What we really want to focus on is our strategic initiatives and kind of how we're going to drive the business, we've talked about a number of different things in the last few quarters. Specifically, we're super excited about the upgraded loyalty program that's expected to come out this fall. And I think the loyalty program is a really robust one, as you know, with 77 million customers in the database, 30 million active customers. It's easily the biggest in the pizza business. And as far as we are concerned, this is just taking it to the next level. And this is making it much more accessible to customers who are actually transacting towards whether they're delivery customers or carry-out customers with many enhanced features and functionality that should drive more frequency. We had that track record in our previous loyalty program launch. We should start seeing some of that as we go forward into this one too. Similarly, I think for an e-commerce platform, we're looking to actually upgrade the e-commerce platform to our next-generation platform. And there too, we saw tremendous uptake. It's 80% digital penetration in our business. So we have a terrific platform, but we have a lead over the competition. We intend to expect -- to extend the lead over the competition by making these investments in technology that accelerate our growth. Both these 2 things that I'm talking about are super important accelerators of growth. It's happened in the past, it will happen again, and that's exactly why we're making these investments. Sorry, Ryan. If you add to that, there's a couple of other areas where it's super important to continue to stay ahead of the game in terms of innovation, whether it's menu innovation, whether it's operational innovation. We've been doing a ton of stuff on that area. We'll keep doing that, too. But I think the most important thing for us is value. And I think as long as we continue to demonstrate value in our product, we will continue to gain more and more volume with our customers because despite what's happened in terms of macro headwinds, our acquisition has been extremely strong. Our retention has been extremely strong. Where we've actually lost a bit of traction on the delivery business is frequency of transactions, really constrained a little bit by the macro. But if we maintain our value and bring in these initiatives on the loyalty program as well as e-commerce over time, we will see that volume come back because the acquisition continues to be robust.

That's a great overview. And that kind of answers my second question, but I'm going to dive a little deeper into it. Just you have 2 distinct businesses, really delivery and carryout. And the delivery business, same-store sales trends there have been pressured driven by the factors you've already discussed. And you've talked about the need for value and service at Domino's to capture delivery. What are you specifically doing on the value side to position the delivery business for an above-average growth cycle when these macro headwinds inevitably recede?

Yes. I think specifically on value, you're exactly on point. And if you think about how much pricing we've taken on average, you probably will see that our pricing has been less than perhaps the competition and perhaps the overall QSR space. And this is specifically because we've been focused on making sure that the product we're delivering is of great value. And I think when you actually look at what's been happening in the commodity markets, especially this year, it started off and the first quarter already softening. And I think since then, we've been seeing lot of headlines in terms of what's been happening in the commodity prices space, and it's continuing to soften. And this essentially is super important because we wanted to make sure we didn't get too far ahead of ourselves in this situation. It's important for profitability, but in the end, our business is predicated on frequency and volume. And we have a very strong database of customers that are actually engaging with the brand and making sure that we continue to stay on value is super critical. The Mix & Match promotions, the updates to the national offer at $6.99 was absolutely the right thing to do because that ensured the flow-through and profitability on those transactions to our franchises and showing up in their profitability and the P&Ls. The thing that we talked about at the beginning of the year was, in certain cases, the menu prices have gotten a bit out of stack with the national pricing. That's been fixed. So we're now in a really good place on value. And as long as we keep on executing on all our strategic initiatives, we will see frequency and volume come back into the business, which is going to drive our sales force and actually drive growth again in that business. And then Brian, just one thing I wanted to just say because the questions come up on the delivery business specifically, and it doesn't really come up recently, but I've had a number of callbacks on this about aggregators. And why are we not working with aggregators. And I want to make sure because there's a lot of confusion about this that I address this head on and just talk about this a little bit. For us, it's a very simple calculation, a simple evaluation process. We just look at what is the incrementality of a potential partnership, weighed against the potential risk of customers who are on our platform, switching out of our platforms into an aggregated platform. And if we see that on a long-term basis, the incrementality of the opportunities is greater than the risk then that calculus leads us to actually partnering with a third-party aggregator. This is the evaluation process I'm describing in the United States, but it's not unique to the United States. It's one that we've done in every single market internationally where we're partnering with aggregators. And that business is now $1 billion in size. And I think we're very comfortable with that. But I think what I wanted to make sure that we lead on is exactly this thought process and this evaluation process for how we think about it. And it's really simple. We get to the point where if the long-term benefit is greater, we sign up. If we get to the point where we say the risk is much greater versus the long-term benefit, we don't. And it's like that. And it's not a static. If things change, the marketplace evolves over time. Actually, you've got to continuously be updating your assumptions as you evaluate the opportunity. And that's exactly what we've been doing.

Just on that. So the bottom line is despite many thinking that you've closed the door on that potential partnership opportunity, it's a constant evaluation process and the door has not been shut.

Absolutely. You're correct.

Got it. And on the carryout side, which is arguably a separate business, everyone knows you've been number one in delivery for a while, but now you're number one in carryout, too. In fact, 50% of your U.S. orders are now coming from carryout. So the order count is split. Can you just explain to the audience why do you believe that this carryout opportunity is incremental and is a separate growth opportunity relative to the delivery business. I get a lot of questions on that, where people have a hard time believing there's not cannibalization or one doesn't share with the other. Why is it so incremental? And why is it a separate growth vehicle?

Yes. So I think the one thing I can do is definitely point to data, right? Because we have the data. And when we look at the data from our database, from our customer database that I just described with 77 million customers in it, we look at the transaction history of those customers. And when we look at the transaction history of those customers, we see that less than 20% switch between channels. And this is over a long period of time that we're actually observing this. It does may go up a little bit here and there, but overall, it's less than 20%. And so what this is, is we definitely see that the psychographic profile of the customers who buy delivery versus buying carryout are quite differentiated. The delivery customer tends to be very interested in convenience, not so -- not as much value oriented. The carryout customer is value-oriented but also is looking for control over all aspects of the experience. So the combination of the psychographic profiles plus the empirical data of how customers have been transacting is what tells us that the overlap is very limited. Then I think you can look at, okay, so if it's incremental, that's great. So why is there so much growth potential in that business? But even though we've had such explosive growth on the carryout business in the last few years, our share in carryout is still significantly below our share in delivery. It's the same product that we're selling. The experience or access in the product is different. The carryout business is a much newer business in the Domino's portfolio. It's just over a decade old, whereas the delivery business is over 60 years old. And so -- as the compounding effect of actually has seen growth on growth continues. We're making enormous strides to getting to our share at least at the same level as delivery and frankly, we see potential to grow our delivery share as well as carryout share beyond what delivery is today. And so that's the way we're looking at our business. We think there's enormous growth potential on carryout. And I think we continue to look at both channels as independent opportunities and the carryout has implemented the delivery business.

That makes sense. And another thing I wanted to touch on is service. It seems like a catalyst that you have sitting within the business is improving your service levels because they have been challenged now for a bit. You went through the intense staffing challenges, which seems to be in the rearview. And you're starting to see some tangible service improvements in the last quarter. I think you said you got a minute better on delivery times. It's -- that's something that's a start of an improvement. You're launching an initiative called Summer of Service. It's a training program when all of your U.S. franchisees are coming to Ann Arbor for one of the largest trading efforts you've had in the history of the company. Can you unpack what the goals of this initiative are and how could it ultimately get the business back on a better path for improving service?

Yes. And I think it's a great question, Brian, because I think there's 2 different levels, right? One is like absolute levels of service and kind of how do they improve. We still don't have the 2019 levels of delivery service, for example. And we want to make sure that we continue to make strides to actually improving even going forward. But some of the services are a slightly different construct. If you think about what's been happening over the last few years, especially during the pandemic, so much of our operational processes has evolved. So much of the technology that's been enabling these operational processes has evolved. And then you have a lower turnover during the course of the pandemic, where you had a number of team members kind of departing and new team members coming in. So this is really an opportunity to just level the playing field across the franchisee system, bring everybody together under one roof, ensure that the training materials that they have received are consistent, and they're all together receiving it. And so this will enable us to be better utilizers of the technologies that are at the disposal of the franchisees to actually get operational effectiveness. And the practices, the SOPs that we have in the stores, again, if there's a best practice, it's standardized and it's applied everywhere. And I think that's going to make a huge difference in terms of productivity to the franchisees and their P&Ls basically will get much better from more efficient cost deployment -- labor deployment essentially. So that, I think, is a big piece of it. You're going to get better service as well. Well, I think the profitability of the individual units gets improved in the process.

Great. And I want to touch on digital because you talked about at the beginning digital and the revamping of some of these systems being a very big opportunity for you. Digital is obviously 80% of your sales. And you're set to make some big changes. You're in the middle of refreshing and improving your loyalty program that was launched back in 2015. And you're making these other investments into your overall e-commerce platform. I'm just trying to understand how impactful these type changes could be. Can you kind of elaborate a little bit more on what you're aiming at actually doing with these relaunches and these overhauls?

No, I think another great question, Brian, because look at 2015, what happened to the company. I think the lead up to 2015 was, I think the digital launch had already happened, and that was on the back of New and Inspired. And so you've seen pretty good growth already after 2015. But when we launched the loyalty program in 2015, we saw a significant increased acceleration of growth that came behind that loyalty program. So that's exactly what we're looking to do. We're looking to basically reaccelerate again with this refresh loyalty program, which will take all the good things that we got from the existing loyalty program and add new bells and whistles to it, to make it much more attractive and even more attractive to those with loyalty database to drive incremental sales growth. So that's the thinking on the loyalty program by itself. Then I think in terms of the e-commerce platform, obviously, it's a very strong platform when it's driving 80% of our sales being digital. So in itself, we are happy with that. But it's important with -- especially with e-commerce technology that we continue to evolve the way technologies are evolving in the marketplace. We had a substantial lead because we started so much ahead back about a decade ago. But as time goes, technology gets older and it needs to be refreshed. We just want to extend our lead. We just want to get right in front of it again and actually make sure we build that lead to be a bigger lead and just have state-of-the-art technology that is very easy for the user to interface with. And I think you're going to hear a lot more about this during Investor Day on exactly what we're trying to basically accomplish with the e-commerce platform. But over time, this will actually drive improved conversion and increased sales as well. Both loyalty and the e-commerce platform, the upgrades are intended to accelerate sales.

Great. And we're going to talk about -- we're going to talk probably a lot about unit growth, but let's first talk about the unit economics first. A piece of your growth puzzle does rely on U.S. franchisees accelerating unit growth later this year and into 2024. You've disclosed that franchisees still have strong EBITDA generation per unit of about $140,000 with 3-year payback. So very strong incentives to build units. I think investors concerned is that while U.S. franchisees should be incentivized to grow the capital return metrics are lower than they were a couple of years ago and EBITDA per store was much higher and investment costs were such -- were much lower. So can you help us understand what drives your confidence that the U.S. unit growth picture has a solid outlook?

Yes. And I think my big piece of confidence comes from 2 piece -- from 2 areas: one, just profitability trends in the units themselves. Q4, we saw significant accelerations behind the Mix & Match, carryout offer basically being raised and the ticket -- the profit flow-through from the ticket increase actually materially improving profitability to the franchisees. Q1, if anything, saw an acceleration in the trend. And so when you take those 2 things, and then we talked about commodity costs and what's happening to commodity costs. So the ticket is basically higher. If commodity costs are moderating, the flow-through becomes materially more. Franchisees are actually enjoying significant improvements in the profitability of their units as we speak. So when we are looking at making investments as we move forward, they were already looking at pretty compelling economics in the beginning of the year. They're looking at even more compelling economics right now because the flow through is getting even better. So even in an increasing construction cost environment, you're seeing significantly improving profitability metrics. So the paybacks, if anything, are just getting better, not worse.

That makes sense. And as it relates to your overall system growth, I think it remains clear that you still have a very bullish long-term view for your business and its ability to grow units when -- we're going to talk about international shortly. But when you merge the international and domestic growth opportunities, you believe that unit growth can grow an annual algorithm of 5% to 7% over the next 2 to 3 years. This remains one of the best unit growth algorithms among scaled public restaurant companies, but its ability to be achieved does seem to be a major investor debate, particularly in the current environment where capital cost, cost of capital are up. What informs you that, that number that, that 5% to 7% is the correct unit growth range for the platform moving forward?

So Brian, I'll take it in 2 parts. I'll take the U.S. first and then I'll come to the international because this is probably a different drivers for both. In the United States, I just talked about the unit economics being solid, really solid. That's one piece of why I'm so confident. The second is we have visibility to the pipeline every year as we actually go into the year. The difference between visibility last year and this year is the execution behind the commitments in the pipeline. Last year, I think we were having a lot of issues with permitting supply chain constraints and so on and so forth. So expected timing is one actually materializing to when they actually did open. This year, we've been seeing pretty consistent trends on, here's what our timing was going to be and here's when the stores should open within a very reasonable margin. I think stores are opening when they should be opening. And as the economics continue to be even more compelling, I'm expecting more sign-ups for stores rather than the other way around. And so I think both those factors give us extremely high confidence, which is why when we talked about the Q1 -- on the Q1 call, we talked about specific cadence of what's going to happen within the growth for United States. We'll see a stabilization price probably in the third quarter, inflection in the fourth quarter continuing into 2024. This is based on visibility. This is based on pipeline. This is based on economics. So it's not speculation. It's not hope. It's what we have in hand. And we have -- the franchisees here now for some of our services. So we're talking to them and having conversations with them all the time. So that's the U.S. piece. The international piece, I think there's a few things going on over there. I think there's been some closures that have actually been happening in a -- so pretty idiosyncratic, I mean, in Brazil, there's been an optimization that's been going on. I think in Russia, our partner that actually branches in Russian market has announced that they're probably going to exit the market. And there's been some closures that have actually happened around that. But if you look at the gross openings. Gross openings are still very strong, and we're very confident that the gross openings will continue to be strong and why. We look at our top 20 international markets by sales. The average payback is around 3 years over there, with all these pressures that we talked about in 2022. And so there's a very compelling reason, just as compelling as I talked about of the U.S. for the international market. So I'll have to go through each market one by one to actually have the same kind of color on it. I'm not going to do that. But I'm telling you that on average, it's a 3-year payback. So on average, it's not that different from the United States. In terms of being compelling to the franchisees to open. And that's why we are really confident that we'll have to deal with some of this noise that we're dealing with in terms of closures. One of our partners announced yesterday, they were going to exit the Denmark market, which is about 27 stores over there. Last year, we had the Italian market being exited. It's -- these were strategic reasons that those partnerships which we agree with, and that's fine. But I think when you look at the underlying health of markets in which we're operating, the vast majority of the markets and every one of the top 20 markets I'm talking about have very, very compelling economics. And that's why the growth is going to be tied to do this.

And on the last call, Russell mentioned that 6 of the top 20 public QSR companies are part of the Domino's family, including DPC Dash, who is your master franchisee in China who just came public earlier this year. How does this dynamic of having such a large public international franchisees shape your view in your strategy of your international business. And any tidbits you can give us on China would be helpful given the potential big growth opportunity there.

Yes. I think, number one, I'll address the broader structure of our master franchisees and having such large public master franchisees as part of our strategy. It makes a ton of sense. When you have this kind of scale that these large master franchisees do, they have the resources to invest in the growth of the brand. And that's precisely why we've partnered with that. So it's one that we think is a very compelling way to do business, and we expect to continue doing business with that. And we touched on China and specifically DPC Dash, but I think I'm going to talk about China and in the context of the entire international business, and then I'll start it into each of the regions. So I'll start with Asia in which China is definitely a huge opportunity within Asia. The growth that we can see coming in China is just unbelievable and astronomical in terms of relative to where we are, the potential growth is very, very strong because the economics are very compelling. And it's a highly developed QSR market where the demand for the Domino's brand is very high. So we continue to see a very strong appetite, not just in Tier 1, Tier 2 cities, but Tier 3 cities and wherever we're actually opening up stores. There's a lot of potential for us to continue to put down more and really apply the fortressing approach to drive much more density and much more growth in the China market with the size of potential stores that we haven't open yet being very significant relative to where we are right now. And that's China. The other market, I think, which is very, very good, is India. In India, essentially, it's a similar population in China. But I think over there, we've probably been in market for a little longer. But even there with less than 2,000 stores in India, the potential for India is significantly above that number in terms of number of stores that we can open, we'll give you more specific numbers during the Investor Day, so you can actually amount to how big this all could be. But I think these 2 markets are going to be material drivers of our business in Asia and international as we move forward into the next few years and big drivers of the sales opportunity. So I'll move out from Asia and I'll move to Europe and talk about a few markets over there. So you've got kind of a mixture of markets which are a little bit more mature and a little bit more with the wide space over there. I think the U.K. is a relatively mature market in Europe. But even though it's relatively mature, there's still good growth that's coming in the U.K. that we are seeing. And this good growth is coming on the back of very compelling same-store sales. Our partner basically was -- had a training update back in, I think, a few weeks ago when they talked about their trends in the business. And ex VAT, which was a disruptor in terms of trends because of the timing of the U.K. VAT release, they were close to double digits in terms of same-store sales. That's very, very strong. And on the back of that to continue to have the growth opportunity that do is -- tells us that there's material growth opportunity in the U.K. and that's our biggest market. On top of that, we've got one of our partners, Alsea, basically has the Spanish market in Europe. They are doing extremely well in the Spanish market, and there's a lot of growth over there that's ahead of us and that has been seen as well. And I think France and Germany are markets with all the white space, too, where we're not quite as penetrated as we should be in that market. So you take the European region, there's plenty of growth there in addition to what we talked about in Asia, and then coming closer to home in the Americas, the I mentioned Alsea just now they have a terrific presence in Mexico, and we continue to actually grow in Mexico in a very good rate. And there's a lot of runway ahead of us for growth over there. And even closer to home is Canada. And Canada has done extremely well. It continues to do very well, and there's more growth in Canada that we've seen as well. So you put all these together, all of these markets are key markets that are going to be a big part of the growth narrative as we look forward. When we talk about the unit growth as well as retail sales growth, a lot of it is coming from the markets I just mentioned.

Got it. Got it. I do want to move to profitability since I have you, the CFO. I want to touch on this. And Sandeep, since day one of coming to the company, you tried to bring a sharper focus to profitability, pricing architecture, G&A leverage, et cetera. Can you speak about your philosophy on EBIT margins and profitability? And what you believe are still the biggest opportunities to improve EBIT margins over the next couple of years?

Yes. No, I think the big one, especially when you had significant cost pressures like we did last year was pricing architecture. Getting that right was very, very important in the face of the changing landscape. And look, we took the right decisions, definitely on the national pricing, where we're seeing the results flow through already by Q4. We've talked about some adjustments in the menu pricing, which we did earlier in the year, and now profitability of flow through, it's very good for the franchisees, which drives the flight. And so I think that's part one. Then I think there's other elements that we do once you get the pricing architecture to optimize flow-through was this volume growth. And you want to get that. Then you got to look at the supply chain, which is a big part of our business model. And there, there is a pretty significant cost structure. And I think we can look at -- we've actually looked at ways to optimize our cost structure very aggressively this year. And if you look at the procurement benefits that we took in the first quarter, that was a big driver of the improvement in gross margins that you actually saw, and you saw a bit of a leveling out of gross margins and expect to see that the rest of the year. It's going to be something that holds because that initiative was -- which will actually hold for definitely with the rest of this year. We've also looked at our fixed cost structures. And as we looked at -- looking at efficiencies in that [indiscernible] closely. So those are big components of the P&L. And then G&A is something we look at to actually manage as a ratio to retail sales and actually drive it at a slower rate than retail sales to great margin leverage. That's something which we've done a really good job, I think, in the past year of looking at all our spend and then we sequencing it and strategically prioritizing where the spend is going for maximum impact to drive long term growth and sales and profitability. So when you put it all together, the whole idea is you grow your EBIT margins, and you want to grow your EBIT dollars and you're going to grow your EBIT margins. And so what we've done now is with the optimization of all these levers, we saw pretty good margin expansion in the first quarter. We will see margin expansion happening pretty much the rest of the year. We will see our full year operating margins going back to pre-pandemic levels this year with the kind of momentum that we're seeing.

This year. Okay.

Yes.

No, that's great color there. I want to move to capital structure real quick before we close it out. With the recent rise in interest rates, capital structure strategies are becoming more in focus for investors. We're getting more questions from investors about our company's capital structures. Can you provide just a road map on how you think about your debt structure and how you anticipate managing it over the coming years? And how are you going to balance that against your $400 million share authorization?

So Brian, great question. And I think as we kind of look at the changing landscape on interest rates and where things have been heading and where they are expected to head. We initially had the luxury of time because the next strip of debt that was coming due was in 2025. And so we just saw and play a bit of a waiting game to see where things land. But if you look back at our history, our leverage against EBITDA is ranged from 4 to 6x, somewhere in that range. And if interest rates stay at current levels, obviously, I think we're going to have much leverage on the balance sheet, and we probably can move towards that low end of that range. If interest rates start reverting to the lows that we saw in 2021, you can probably be more towards the high end of that range. And so that -- I would kind of bracket where leverage would be. But what we would expect to do, though, is essentially deleverage naturally through growing earnings because we have time to actually refinance our mix structures. And I think with the natural growth in the business, the leverage automatically comes down until we get to the next refinancing point. And our capital allocation principles don't change. I mean it's return of capital to shareholders, the dividends and share repurchases. We'll continue to deploy in that fashion and that consistency is expected.

Great. And lastly, you are going to host a 2023 Investor Day. You're going to host it in the fourth quarter, an event that we're very excited to attend. I don't know if you're willing to give us a sneak peek or I know you don't want to give us all your cards about what you're going to show us at Investor Day, but is there anything you want investors thinking about? Your communication goals for this event? What are you trying to accomplish with this Investor Day?

Well, I think it's actually pretty simple in terms of construct. And I'm not going to give you details right now because that's why we got the Investor Day. But what we want to do is highlight our strategic initiatives and really the top strategic initiatives. Then what we want to do is show you the financial outcomes as a result of the strategic initiatives and then help bridge the gap between those initiatives and those financial outcomes. So you get some level of granularity on how we're going to get there and give you the confidence on how we're actually going to get there in our execution plans. That's the high-level idea of what we want to do at our Investor Day. And I think you're going to see that by the showcasing of all of our resources that we'll bring to the discussion.

Great. Well, somehow, we're already out of time. Time flies. Thank you so much for participating in our 2023 Consumer Conference. We appreciate your time, and we hope you have a great rest of your day. Thank you, everybody, for joining us on the webcast. That's Domino's Pizza. Thank you.

Thank you, Brian.