Stock of the Week - Domino's Pizza (02.01.2025)

Domino's Pizza (DPZ.US), the world's largest pizza chain, faces increasing competitive pressures in its core markets while navigating challenging international expansion. Despite recent headwinds, the company maintains its position as a leading QSR operator with strong unit economics and expanding digital capabilities. The company's recent announcement to transfer its listing to NASDAQ after 20 years on the NYSE marks a new chapter in its evolution.

Q3 FY24 Results 

For the third quarter, Domino's reported:

• Revenue: $1.08 billion (+4.9% year-over-year) vs. estimate $1.099 billion
• Adjusted EPS: $4.19 vs. $4.18 year-over-year
• U.S. Same-Store Sales: +3.0% year-over-year
• International Same-Store Sales: +0.8% year-over-year
• Global Net Store Growth: 72 units
• Operating Margin: 16.8% (+100bps year-over-year)

Earnings vs Estimates. Source: Bloomberg

Strategic Evolution 

Domino's is navigating what CEO Russell Weiner describes as the "pizza wars," with heightened competition in value offerings across the QSR pizza segment. The company's strategy focuses on balancing value initiatives with technological innovation and operational efficiency. A key development has been the successful integration of third-party delivery through UberEats, which now represents 2.7% of U.S. sales, up from 1.9% in Q2. This partnership is expected to reach 3%+ of sales by year-end 2024, with approximately two-thirds of these sales being incremental.

The company's enhanced loyalty program, launched in Q4 2023, continues to drive customer engagement with multiple redemption tiers that have proven particularly effective in the carryout segment. Carryout orders with loyalty redemptions in 1H24 were twice as high year-over-year, demonstrating the program's success in driving frequency and retention.

Competitive Position 

Domino's maintains its leadership position in the U.S. QSR pizza segment with over 20% market share, though competitive pressures have intensified. Major rivals have adopted similar value price points, with Pizza Hut and Papa John's matching Domino's historically dominant $6.99-$7.99 promotional offerings. Despite this increased competition, Domino's superior unit economics and operational efficiency provide a sustainable competitive advantage, with average U.S. franchise store-level profitability expected at $170,000 for FY24, up from $162,000 in FY23.

The company's digital capabilities remain a key differentiator, with approximately 85% of orders coming through digital channels. A five-year partnership with Microsoft announced in October 2023 aims to enhance both consumer ordering experience and in-store operations through AI-driven personalization.

International Expansion Challenges 

International growth has faced significant headwinds, leading to two downward revisions in unit growth guidance during 2024. The company now expects 800-850 net new units globally in 2024, down from the original target of 1,100+. These challenges are particularly pronounced in certain markets, with master franchisee Domino's Pizza Enterprises (DPE) experiencing difficulties in Japan and France.

However, bright spots remain in key growth markets like China and India, which are expected to contribute 40-50% of global openings. DPC Dash in China (currently at ~1,000 units) and Jubilant in India (at ~2,800 units) continue to show strong performance and expansion potential.

Management Guidance 

Looking ahead, management has moderated its near-term outlook:

• 2024 global retail sales growth revised to ~6% (down from 7%+)
• 2024 income from operations growth maintained at ~8%
• 2025 expectations aligned with 2024 levels
• Long-term guidance (2026-2028) maintained at 7%+ retail sales growth and 8%+ operating income growth

Investment Risks 

Key risks include:

• Intensifying competition in the value segment
• International expansion challenges, particularly in mature markets
• Potential impact of GLP-1 drugs on consumer behavior
• Rising interest rates affecting franchisee expansion capabilities
• Ongoing macroeconomic pressures on lower-income consumers

Wall Street Perspective 

Notable recent developments include Berkshire Hathaway's new stake of 1.28 million shares in Q3 2024, signaling Warren Buffett's confidence in the company's long-term prospects. Morgan Stanley maintains an overweight rating with a $510 price target, though recently adjusted down from $520, citing near-term growth challenges but maintaining confidence in the company's competitive position.

Investment Conclusion 

While Domino's faces near-term headwinds from increased competition and international growth challenges, its strong unit economics, digital leadership, and operational efficiency provide a solid foundation for long-term growth. The company's ability to maintain margins while competing aggressively on value, combined with expansion opportunities in key international markets and the potential upside from third-party delivery partnerships, suggests a resilient business model. However, investors should monitor the competitive dynamics in the U.S. market and the pace of international recovery, particularly in troubled markets under DPE's management.

Valuation

We based our projections on historical averages and company projections, assuming a continued delivery of growth scenario for the company. This results in a 6.5% revenue growth and a 19% operating margin across the 5-year forecast. Considering the substantial influence of terminal value in DCF analysis, especially for shorter forecast periods, we’ve applied a 3.5% revenue growth and 7.5% terminal WACC, down from 9% in forecast years.

Under these assumptions, our model suggests an intrinsic value of $421.69 per share, indicating potential that valuation is in line with current share price. It’s important to note the high sensitivity of DCF-derived intrinsic values to input assumptions. Below, two sensitivity matrices illustrate different Operating Margin and Revenue Growth scenarios, as well as Terminal WACC and Terminal Revenue Growth variations.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Recommendations: Domino’s Pizza has 34 recommendations, with 22 "buy" and highest price of $559, 11 “hold” and one “sell” with lowest price of $370. The 12-month average stock price forecast is $480.52, implying a 14.5% upside potential from the current price.

Technical analysis (Daily interval): 

Domino’s Pizza is currently trading above the 78.6% Fibonacci retracement level. For bulls, the first target lies at the 61.8% Fibonacci retracement level at $427.4, followed by the 100-day SMA. The 100-day SMA has historically acted as a significant support or resistance level depending on the prevailing momentum. A successful breakout above this level could reignite bullish momentum, with the next target at the 50-day SMA.

For bears, a retest of September’s low at $396 could pave the way for further downside, potentially testing lower support levels. The RSI is consolidating after showing bearish divergence, which may indicate waning strength for the bears. Meanwhile, the MACD continues to diverge lower, signaling caution for bullish traders. Source: xStation