Domino's Pizza: Day Two 🍕

In Day One of this deep dive, you learned that timing factors is just as important as picking stocks.

If you recall, we are now in a growth and momentum-oriented market, where companies like Domino’s Pizza tend to underperform.

This is still a growth company, but the market treats it as a value play considering its discount and the fact that its growth is only attractive in the consumer space, nothing compared to AI.

On the other hand, why would investors worry about the quality factor of this company? After all, SpaceX is going to IPO at nearly $2 trillion with zero earnings.

Well,

When a record $700 billion of supply hits the market all at once, there will be very little to show for these momentum and growth narratives.

I’m guessing that’s when quality and fundamentals begin to matter again.

In other words, when Domino’s Pizza begins to outperform, so time is running out.

As excited as I am about this project, it is only one in a dozen of other companies that look just as good (if not better) in our pipeline.

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Time to find out whether Domino’s really makes the cut…

With the broader thesis already covered, we will dive deeper into the business, why it remains as strong as ever, and why today’s price embeds some pretty weak expectations.

After we correct these expectations, a valuation range can be considered for our investment purposes (and yours).

Just one more thing…

Here’s a free pitch deck made for you to download and keep handy as we go through a more detailed analysis of the business and its valuation, enjoy!

There’s a good reason why Domino’s Pizza is “The largest pizza company in the world” according to management comments in their 10-K.

Over 22,000 locations, 90 markets, and happy franchisees all around.

That’s the key word here, happy franchisees.

Because Domino’s Pizza is so profitable, it is able to share the profits with franchisees through better terms, flexible agreements, and a near guarantee of success.

They do this in two ways:

It’s a beautiful thing really, as we said yesterday, Domino’s has cracked a very tough business in a very successful way.

This is where shrewd investors would approve, as the above simplification suggests able management capability and efficiency, translated into real profits.

As we showed you yesterday, Domino’s Pizza should not be treated as a pizza business.

Rather, like the McDonald’s example, you should look at Domino’s as a supply and logistics company that happens to sell pizzas.

With over 60% of revenues coming from the supply chain business, it’s important to understand how the other businesses work together to reinforce the profitability and moat of the company.

The beautiful thing is that we do not need to understand an uncertain AI capex future, returns on tokens and productivity, or anything that seems reserved for overly intelligent players.

It’s as simple as a business can be.

Let’s understand where the real profits come from here.

International stores, since they don’t include any company-owned locations, carry the largest margin at 85%.

Domino’s takes the upfront risk in company-owned stores, setting up machinery, implementing technology, and playing around with promotional offers and potentially failed products (there’s a croissant pizza being tested right now).

This is why U.S. stores have a 50% difference in margins, otherwise they’d likely be pretty close to the international locations at 85%.

The biggest player, the supply chain business, is the least profitable operation of the three, but the one that commands the most market value as seen in the revenue segmentation.

Management knows that this thin margin business is critical for future success, and they act accordingly.

Nearly half of all company expenditures go toward the supply chain business, even though it carries the thinnest operating margin.

This would normally be a red flag, why send good money after bad money?

Because as store counts continue to expand in the U.S. and internationally, the supply chain business sees added demand and pressure to deliver.

It also means more revenue coming into Domino’s as a whole now that new stores are dependent on the supply chain business.

Now that these three segments are understood, let’s get down to what really matters.

It is a well-known fact that margins and profitability metrics are the window to identifying moats.

For Domino’s Pizza, double digits of ROA and ROIC tell you all you need to know about their stance in the industry.

Because their franchise locations are so profitable (85% margins), and those profits are kicked back into the supply chain business, Domino’s allows franchisees to enjoy similar economics.

Another company that famously does this is Costco. Their extensive supply chain networks, supplier and customer agreements, and competitive prices allow for pass-down benefits reflected in their profits and shareholder returns.

This is why Domino’s stock has returned over 2,000% since its IPO in 2004, compared to the S&P 500 return of 560%.

Now we must dig into the fact that markets are treating Domino’s in a different way now, which was covered in Day 1 of this deep dive.

Rather than a growth stock, markets have begun treating this stock as a value play as if there was no further growth to the brand and business.

Which isn’t true.

Year after year, Domino’s continues to grow its store count and global footprint, expanding on the leverage it has already achieved through industry-leading margins and business model.

That means,

Every new store opening creates an additional revenue stream to the supply chain business and royalties for us investors to enjoy.

In other words, the lack of growth markets fear is not real, and that creates a tremendous expectations disconnect opportunity for us.

At today’s price of roughly $315 per share, the expectations embedded in the stock are as follows:

Right off the bat, we can all agree that Domino’s is more than likely to beat these expectations, notably on the revenue growth line.

Especially so as store count continues to grow, creating further economies of scale for the supply chain business and revenue streams from new franchisees.

The concept of residual value, or economic value, is another great way for you to figure out what the market is expecting.

Here’s the idea behind the valuation method:

Taking all of this, here’s what today’s price of $315 implies as far as the return and moat erosion in Domino’s Pizza:

This is exactly where the deal becomes interesting, because you are beginning to realize just how absurd these expectations are, and how much opportunity to outperform there currently is.

After digging through the rest of the company, and performing several valuation exercises to land at a more realistic price for Domino’s Pizza, here are the assigned target prices:

Our time horizon for this investment is set at five years or longer, and would agree that today’s price offers an attractive entry under the following structure:

Once the entire position is put on, we will update Offside Premium members on risk management and options strategies to collect premium income as prices approach our target valuation.

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We’re starting this week off with some great deals and a deep dive on the AI trade, its risks, and why Michael Burry may be right in calling it a fraud.

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.