The Good News, Bad News Story That Is Domino’s

On Thursday, Ann Arbor-based Domino's Pizza (DPZ) reported Q3 2022 financial results. They were mixed. DPZ shares jumped more than 10% in early trading despite the mediocre results.

While the company's results were decent, another piece of news excited current shareholders and those sitting on the fence. 

The pizza chain sold 114 company-owned restaurants in Utah and Arizona for $41.1 million. The move pushes the pizza franchisor further into an asset-light business model. 

That’s good news. Here’s why.

Domino’s Needed a Break to Go Its Way

Domino’s stock is down nearly 40% year-to-date. It’s trading around the same price it did in March 2021, almost 18 months ago. Former CEO Richard Allison, who retired at the end of April, left the company after 46 months in the top job.

Let’s consider how the past three CEOs have done while heading up the pizza company.

First, there is the current CEO, Russell Weiner. He took the top job on May 1. Before becoming CEO, he was the COO for the company's U.S. division from July 2020. DPZ has traded sideways in the six months since.

Richard Allison became CEO on July 2, 2018. DPZ stock gained 18% over the 46 months he was chief executive. Over the same period, the S&P 500 gained 35% or nearly double.

The man Allison replaced, Patrick Doyle, became CEO of Domino’s in January 2010. At the time, its shares traded for $8.40. When he stepped down, they were $282.20, 3,260% higher than when he started. It’s fair to say that Doyle broke the mold when he turned around Domino’s pizza business.    

The double-whammy of good news about Domino’s business was more than welcome by long-suffering DPZ shareholders.

The Asset-Light Business Model Lives

By selling 114 units to franchisees, not only did it get $41.1 million from the sale -- the gain on the transaction will be announced in its Q4 2022 results --- but it also reduced its company-owned locations by 28% from 402 as of Sept. 11, to 288. 

Based on an average of $361,000 for each unit sold [$141.1 million divided by 114), Domino’s remaining company-owned stores are worth approximately $104 million. There’s very little value in the stores themselves. The cash flow matters, so the company is constantly buying stores from franchisees in certain states and re-franchising stores in other states.

“The franchising or refranchising strategy for us is really more -- I would think of it as a growth strategy,” Weiner stated in its Q3 2022 conference call.

Ultimately, out of 19,519 stores worldwide, just 288 are company-owned. That’s less than 1.5% of its total footprint. 

The company-owned stores are for in-the-field research. They don’t have to be nearly as profitable as its franchisee locations. After all, if franchisees aren’t happy, the business is a bust.    

The Third Quarter Was Better Than Expected

The highlight of the third quarter was a 2% increase in U.S. same-store sales, 110 basis points better than the analyst estimate of 0.9% growth. Its International same-store sales had a decrease of 1.8% during the quarter. 

Thanks to the addition of 225 new stores worldwide, its global retail sales, excluding currency, increased by 4.7%.

Its revenues during the quarter increased 7.2% to $1.07 billion from $998.0 million a year earlier. Unfortunately, its net income in the third quarter fell 16.5% to $100.5 million from $120.4 million a year earlier.

As for free cash flow – vital to an asset-light business model – it’s taken a step back in 2022. In the first nine months of 2021, Domino's generated $433.9 million in free cash flow, down 55.2% from $279.6 million in 2022. 

On an annualized basis, the company’s full-year free cash flow should be $373 million, or 3.1% of its market cap. I consider anything under 4% to be overvalued.  

Despite the mixed report, CEO Weiner is excited about the future.

“As we begin the fourth quarter, I believe Domino’s is poised to emerge from these volatile times stronger than ever,” Weiner said in the company’s press release.

Analysts aren't nearly as convinced. Of the 33 analysts covering its stock, only 11 rates it a Buy or Overweight. The rest either have it as a Hold, Underweight, or Outright sell.

I’d stay away until the markets and the economy move in the right direction.

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