Dominos Pizza (“Wide Moat”) reported mixed third quarter results.
Its sales of $1.07 billion and diluted earnings per share (EPS) of $2.79 beat our estimates of $1.04 billion and $2.64, respectively.
But restaurant profitability fell more than 750 basis points from a year ago to just 12.3%, although this was a smaller annual decline than seen. during the second trimester.
We point to raw material cost inflation (up 13.4%), a modest decline in traffic and growth in hourly wages as the likely culprits.
We expect the third quarter to be the low point of profitability for the chain, as input cost inflation has begun to slow and the company embraces price increases in its delivery service.
Despite short-term headwinds, we continue to view Domino’s as one of the restaurateurs best positioned to weather a period of restraint and macroeconomic pressure.
We expect to reduce our fair value estimate of $405 by 4% to 5%, given the weaker profitability and weaker near-term unit growth it likely foreshadows.
We appreciate Domino’s asset-light and franchise-heavy operating structure, and the name represents our top choice in the US restaurant industry.
The shares are trading at about a 15% discount to our revised fair value estimate, despite a 9%-10% stock price rebound following the earnings release.
Domino’s maintains some of the best store-level savings in the industry, supporting what we believe is a story of sustainable growth, particularly as the company’s consolidation strategy continues to bear fruit; the delivery business has quietly matched the size of the company’s solid delivery service and competes better on relative value, without the burden of delivery charges and tips.
Finally, pizza is an attractive category, with a low cost per serving, and the company only generates 6% to 7% of annual sales (but 25% of operating income) abroad, which helps to mitigate the short-term pressure from a strong dollar.
Domino’s appears to us to be one of the best positioned restaurant operators in our coverage to capture market share in a challenging macro environment that has led to a 630 basis point annual contraction in restaurant margin for the median business in our coverage. .
We expect a prolonged recovery in margins for the pizza chain, with restaurant-level margins returning to around 15% by 2024 (difficult to raise menu prices amid lower spending and sentiment) consumers), although we view a full recovery as plausible in the long term, with our forecast calling for restaurant-level margins in 2026 (2031) of 19.2% (22%) versus a 5-year median of 22.1% .
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